## Help me with the Trad vs Roth 401k Math

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Topic Author
justsomeguy2018
Posts: 310
Joined: Wed Oct 03, 2018 8:11 pm

### Help me with the Trad vs Roth 401k Math

Help me understand how the tax rate in retirement vs current marginal rate is all that matters when thinking of tax efficiency of Roth vs Trad. Here is how I see math if I max out the 401k at a fictional 20% current tax bracket vs 10% retirement bracket:

Trad: \$19,000 contribution, grows to \$190,000 in retirement. Taxes in retirement = .10 x \$190,000 = \$19,000. Net = \$171,000
Roth: \$19,000 contribution, grows to \$190,000 in retirement. Taxes currently paid = .20 x \$19,000 =\$3,800. Net = \$186,200

What am I missing here? Is the assumption that the \$3,800 paid in taxes on Roth, would have been invested in a Taxable account, so the growth would be equivalent? If so, expound on that for me.

Most of the time I see this example explained as the Roth contribution would end up equal with equal tax rates because it would only be \$15,200 after you paid \$3,800 in taxes, but what if you paid those \$3800 taxes, and still maxed out at the \$19,000 rate? How could the Trad possibly be better, assuming an extremely high growth rate in the Roth?

Can someone show me mathematically how maxing out a Roth vs Trad 401k would generate the same final net value if the tax rate stayed exactly the same?

willthrill81
Posts: 15057
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

### Re: Help me with the Trad vs Roth 401k Math

justsomeguy2018 wrote:
Sat Feb 16, 2019 7:52 pm
Help me understand how the tax rate in retirement vs current marginal rate is all that matters when thinking of tax efficiency of Roth vs Trad. Here is how I see math if I max out the 401k at a fictional 20% current tax bracket vs 10% retirement bracket:

Trad: \$19,000 contribution, grows to \$190,000 in retirement. Taxes in retirement = .10 x \$190,000 = \$19,000. Net = \$171,000
Roth: \$19,000 contribution, grows to \$190,000 in retirement. Taxes currently paid = .20 x \$19,000 =\$3,800. Net = \$186,200

What am I missing here? Is the assumption that the \$3,800 paid in taxes on Roth, would have been invested in a Taxable account, so the growth would be equivalent? If so, expound on that for me.

Most of the time I see this example explained as the Roth contribution would end up equal with equal tax rates because it would only be \$15,200 after you paid \$3,800 in taxes, but what if you paid those \$3800 taxes, and still maxed out at the \$19,000 rate? How could the Trad possibly be better, assuming an extremely high growth rate in the Roth?

Can someone show me mathematically how maxing out a Roth vs Trad 401k would generate the same final net value if the tax rate stayed exactly the same?
What you're ignoring in your example is the taxes that must be paid on the Roth contributions. This means that your example isn't apples to apples. Your Roth contributions would only be \$15,200. If they then grew to \$152,000 in retirement, that would be your net. So you would be better off with the traditional 401k.

Think of it in simpler terms to get your head wrapped around it. Assuming the 20% current and 10% retirement taxes, which would you rather pay? With traditional (aka tax-deferred) accounts, you pay the latter. With Roth accounts, you pay the former. Therefore, given the choice between the two, you would only pick the Roth if your current marginal tax bracket was at least the same as your retirement tax bracket. Now there are other reasons why you might or might not choose a Roth, but when it comes to taxes paid, that's it.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

Topic Author
justsomeguy2018
Posts: 310
Joined: Wed Oct 03, 2018 8:11 pm

### Re: Help me with the Trad vs Roth 401k Math

willthrill81 wrote:
Sat Feb 16, 2019 7:57 pm
justsomeguy2018 wrote:
Sat Feb 16, 2019 7:52 pm
Help me understand how the tax rate in retirement vs current marginal rate is all that matters when thinking of tax efficiency of Roth vs Trad. Here is how I see math if I max out the 401k at a fictional 20% current tax bracket vs 10% retirement bracket:

Trad: \$19,000 contribution, grows to \$190,000 in retirement. Taxes in retirement = .10 x \$190,000 = \$19,000. Net = \$171,000
Roth: \$19,000 contribution, grows to \$190,000 in retirement. Taxes currently paid = .20 x \$19,000 =\$3,800. Net = \$186,200

What am I missing here? Is the assumption that the \$3,800 paid in taxes on Roth, would have been invested in a Taxable account, so the growth would be equivalent? If so, expound on that for me.

Most of the time I see this example explained as the Roth contribution would end up equal with equal tax rates because it would only be \$15,200 after you paid \$3,800 in taxes, but what if you paid those \$3800 taxes, and still maxed out at the \$19,000 rate? How could the Trad possibly be better, assuming an extremely high growth rate in the Roth?

Can someone show me mathematically how maxing out a Roth vs Trad 401k would generate the same final net value if the tax rate stayed exactly the same?
What you're ignoring in your example is the taxes that must be paid on the Roth contributions. This means that your example isn't apples to apples. Your Roth contributions would only be \$15,200. If they then grew to \$152,000 in retirement, that would be your net. So you would be better off with the traditional 401k.
But this is where I mentioned above: "but what if you paid those \$3800 taxes, and still maxed out at the \$19,000 rate?"

Can't you contribute \$19,000 to the Roth? Or are you saying you can only contribute \$15,200 to a Roth 401k?

lakpr
Posts: 3407
Joined: Fri Mar 18, 2011 9:59 am

### Re: Help me with the Trad vs Roth 401k Math

You are conveniently (or in error) ignoring the \$3800 you paid in taxes now, which would grow at the same rate of investments to be equivalent to \$38000 at the time you withdraw from these accounts.

willthrill81
Posts: 15057
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

### Re: Help me with the Trad vs Roth 401k Math

justsomeguy2018 wrote:
Sat Feb 16, 2019 8:38 pm
willthrill81 wrote:
Sat Feb 16, 2019 7:57 pm
justsomeguy2018 wrote:
Sat Feb 16, 2019 7:52 pm
Help me understand how the tax rate in retirement vs current marginal rate is all that matters when thinking of tax efficiency of Roth vs Trad. Here is how I see math if I max out the 401k at a fictional 20% current tax bracket vs 10% retirement bracket:

Trad: \$19,000 contribution, grows to \$190,000 in retirement. Taxes in retirement = .10 x \$190,000 = \$19,000. Net = \$171,000
Roth: \$19,000 contribution, grows to \$190,000 in retirement. Taxes currently paid = .20 x \$19,000 =\$3,800. Net = \$186,200

What am I missing here? Is the assumption that the \$3,800 paid in taxes on Roth, would have been invested in a Taxable account, so the growth would be equivalent? If so, expound on that for me.

Most of the time I see this example explained as the Roth contribution would end up equal with equal tax rates because it would only be \$15,200 after you paid \$3,800 in taxes, but what if you paid those \$3800 taxes, and still maxed out at the \$19,000 rate? How could the Trad possibly be better, assuming an extremely high growth rate in the Roth?

Can someone show me mathematically how maxing out a Roth vs Trad 401k would generate the same final net value if the tax rate stayed exactly the same?
What you're ignoring in your example is the taxes that must be paid on the Roth contributions. This means that your example isn't apples to apples. Your Roth contributions would only be \$15,200. If they then grew to \$152,000 in retirement, that would be your net. So you would be better off with the traditional 401k.
But this is where I mentioned above: "but what if you paid those \$3800 taxes, and still maxed out at the \$19,000 rate?"

Can't you contribute \$19,000 to the Roth? Or are you saying you can only contribute \$15,200 to a Roth 401k?
By contributing \$19k to the Roth, you are effectively contributing more than with the traditional, so it's not a 'fair' comparison.

Yes, of course you can contribute \$19k to the Roth. But this is only appropriate if you are planning on maxing out all of your tax-advantaged space (e.g. 401k, IRAs, HSA, etc.).
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

kaneohe
Posts: 6017
Joined: Mon Sep 22, 2008 12:38 pm

### Re: Help me with the Trad vs Roth 401k Math

Assume max contribution were 10K (for math ease..........you can scale it up or down). Tax rate is 20% now/later. You have a 2K side fund in taxable.
1)Traditional............you put 10K in, pay no taxes on that income because of deduction so you still have 2K in side fund. N yrs later
both have doubled to 20K in traditional and 4K in taxable. You withdraw the funds and pay the 20% in taxes. You are left with
16K from the traditional . You have 2K gain in taxable and pay 0% in CG taxes and are left w/ 4K- . The - is due to tax drag on the taxable account. Total is 20K-
2)Roth..........you put 10K in, and use the 2K taxable acct to pay the 20% tax so are left only with a Roth. It also doubles in N yrs
and you are left w/ 20K after withdrawal from Roth (assumes you met the age 59.5/5 yr clock to w/d earnings w/o tax/penalty.

End result is that the accts are basically equal tho there may be a slight edge to the Roth due to taxation issues of gain on taxable acct
(maybe rate is 15% , not 0) and because of tax drag over the yrs.

***************************************************************************************
If you don't have extra funds to pay the tax on the Roth, then your Roth contribution will be lower
1)Traditional.........put in 10K. N yrs later it has doubled to 20K. You pay 20% taxes to get it out and end up w/ 16K.
2)Roth............you pay 2K taxes on the 10K and put the remaining 8K in the Roth. N yrs later it has doubled to16K.

*********************************************************************************
you can also do the calculation for a 10% tax rate later and see how the traditional comes out ahead.
Last edited by kaneohe on Sat Feb 16, 2019 9:32 pm, edited 1 time in total.

Topic Author
justsomeguy2018
Posts: 310
Joined: Wed Oct 03, 2018 8:11 pm

### Re: Help me with the Trad vs Roth 401k Math

lakpr wrote:
Sat Feb 16, 2019 8:46 pm
You are conveniently (or in error) ignoring the \$3800 you paid in taxes now, which would grow at the same rate of investments to be equivalent to \$38000 at the time you withdraw from these accounts.
Not exactly, I said this above: Is the assumption that the \$3,800 paid in taxes on Roth, would have been invested in a Taxable account, so the growth would be equivalent? If so, expound on that for me.

By expound on that, what I mean is, show me how \$3,800 in a taxable account has the same tax equivalency over 30 years as \$3,800 in a tax-deferred 401k account. Taxable account incurs interest and dividends every year which will be taxed at different rates over time than the \$3,800 growing tax-deferred until withdrawal, no?

Topic Author
justsomeguy2018
Posts: 310
Joined: Wed Oct 03, 2018 8:11 pm

### Re: Help me with the Trad vs Roth 401k Math

willthrill81 wrote:
Sat Feb 16, 2019 8:56 pm
justsomeguy2018 wrote:
Sat Feb 16, 2019 8:38 pm
willthrill81 wrote:
Sat Feb 16, 2019 7:57 pm
justsomeguy2018 wrote:
Sat Feb 16, 2019 7:52 pm
Help me understand how the tax rate in retirement vs current marginal rate is all that matters when thinking of tax efficiency of Roth vs Trad. Here is how I see math if I max out the 401k at a fictional 20% current tax bracket vs 10% retirement bracket:

Trad: \$19,000 contribution, grows to \$190,000 in retirement. Taxes in retirement = .10 x \$190,000 = \$19,000. Net = \$171,000
Roth: \$19,000 contribution, grows to \$190,000 in retirement. Taxes currently paid = .20 x \$19,000 =\$3,800. Net = \$186,200

What am I missing here? Is the assumption that the \$3,800 paid in taxes on Roth, would have been invested in a Taxable account, so the growth would be equivalent? If so, expound on that for me.

Most of the time I see this example explained as the Roth contribution would end up equal with equal tax rates because it would only be \$15,200 after you paid \$3,800 in taxes, but what if you paid those \$3800 taxes, and still maxed out at the \$19,000 rate? How could the Trad possibly be better, assuming an extremely high growth rate in the Roth?

Can someone show me mathematically how maxing out a Roth vs Trad 401k would generate the same final net value if the tax rate stayed exactly the same?
What you're ignoring in your example is the taxes that must be paid on the Roth contributions. This means that your example isn't apples to apples. Your Roth contributions would only be \$15,200. If they then grew to \$152,000 in retirement, that would be your net. So you would be better off with the traditional 401k.
But this is where I mentioned above: "but what if you paid those \$3800 taxes, and still maxed out at the \$19,000 rate?"

Can't you contribute \$19,000 to the Roth? Or are you saying you can only contribute \$15,200 to a Roth 401k?
By contributing \$19k to the Roth, you are effectively contributing more than with the traditional, so it's not a 'fair' comparison.
I am not talking about a so-called 'fair' comparison.

I am talking about a real life example of maxing out a Roth 401k vs maxing out a Traditional 401k and how we are told they are supposed to end up equal if the tax rates are the same. By my math in my post, they would not end up equal and the Roth would win every time assuming a high enough rate of tax-free growth.

I appreciate the responses (I am looking for answers/help) but so far none of them have addressed any flaws in my math/logic, to my knowledge.

Someone noted the \$3800 in taxes would get invested and grow at same rate in a taxable account (I alluded to this also in my post) and that is how they end up equal, but \$3800 in a taxable account would not grow at the same rate as a tax-deferred account due to tax drag of interest and dividends, am I wrong?

Topic Author
justsomeguy2018
Posts: 310
Joined: Wed Oct 03, 2018 8:11 pm

### Re: Help me with the Trad vs Roth 401k Math

kaneohe wrote:
Sat Feb 16, 2019 9:03 pm
Assume max contribution were 10K (for math ease..........you can scale it up or down). Tax rate is 20% now/later. You have a 2K side fund in taxable.
1)Traditional............you put 10K in, pay no taxes on that income because of deduction so you still have 2K in side fund. N yrs later
both have doubled to 20K in traditional and 4K in taxable. You withdraw the funds and pay the 20% in taxes. You are left with
16K from the traditional . You have 2K gain in taxable and pay 0% in CG taxes and are left w/ 4K- . The - is due to tax drag on the taxable account. Total is 20K-
2)Roth..........you put 10K in, and use the 2K taxable acct to pay the 20% tax so are left only with a Roth. It two doubles in N yrs
and you are left w/ 20K after withdrawal from Roth (assumes you met the age 59.5/5 yr clock to w/d earnings w/o tax/penalty.

End result is that the accts are basically equal tho there may be a slight edge to the Roth due to taxation issues of gain on taxable acct
(maybe rate is 15% , not 0) and because of tax drag over the yrs.
Thanks, this is type of answer I was looking for - the Roth would still win due to the tax drag over time of money in a taxable account, right? I am looking for an example of how or why that assumption might be wrong and the two would still be equivalent.

FiveK
Posts: 8000
Joined: Sun Mar 16, 2014 2:43 pm

### Re: Help me with the Trad vs Roth 401k Math

justsomeguy2018 wrote:
Sat Feb 16, 2019 9:25 pm
Someone noted the \$3800 in taxes would get invested and grow at same rate in a taxable account (I alluded to this also in my post) and that is how they end up equal, but \$3800 in a taxable account would not grow at the same rate as a tax-deferred account due to tax drag of interest and dividends, am I wrong?
See Maxing out your retirement accounts for the background, and either of the two spreadsheets linked there to calculate specific cases.

Does that explain it?

KlangFool
Posts: 14560
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Help me with the Trad vs Roth 401k Math

justsomeguy2018 wrote:
Sat Feb 16, 2019 9:20 pm
lakpr wrote:
Sat Feb 16, 2019 8:46 pm
You are conveniently (or in error) ignoring the \$3800 you paid in taxes now, which would grow at the same rate of investments to be equivalent to \$38000 at the time you withdraw from these accounts.
Not exactly, I said this above: Is the assumption that the \$3,800 paid in taxes on Roth, would have been invested in a Taxable account, so the growth would be equivalent? If so, expound on that for me.

By expound on that, what I mean is, show me how \$3,800 in a taxable account has the same tax equivalency over 30 years as \$3,800 in a tax-deferred 401k account. Taxable account incurs interest and dividends every year which will be taxed at different rates over time than the \$3,800 growing tax-deferred until withdrawal, no?
justsomeguy2018,

1) Why that \$3,800 cannot be invested in a Roth IRA?

2) Roth 401K should be compared with Trad. 401K with Roth IRAs.

3) Roth 401K will be a sure loser in that comparison.

KlangFool

lakpr
Posts: 3407
Joined: Fri Mar 18, 2011 9:59 am

### Re: Help me with the Trad vs Roth 401k Math

Of course there will be a bit of tax drag on the \$3800 assumed to have been grown tenfold to \$38000. It will be slightly lower. For simplicity’s sake, assume 2.5% qualified dividends on the growth, taxes at 15% rate. The tax drag approximately would be (\$38000 - \$3800) * 0.025 * .15 = \$128

Edited to add: Klangfool makes an excellent point about why we aren’t considering the \$3800 to have been invested in a Roth IRA. But as my crude calculations above show, even if we did consider the amount to have been invested in the taxable account, the tax drag is minor.

kaneohe
Posts: 6017
Joined: Mon Sep 22, 2008 12:38 pm

### Re: Help me with the Trad vs Roth 401k Math

Assumptions have been that traditional is fully deductible. That may not always be true for some folks. That makes the case of lower tax rates later more complex.

Topic Author
justsomeguy2018
Posts: 310
Joined: Wed Oct 03, 2018 8:11 pm

### Re: Help me with the Trad vs Roth 401k Math

KlangFool wrote:
Sat Feb 16, 2019 9:30 pm
justsomeguy2018 wrote:
Sat Feb 16, 2019 9:20 pm
lakpr wrote:
Sat Feb 16, 2019 8:46 pm
You are conveniently (or in error) ignoring the \$3800 you paid in taxes now, which would grow at the same rate of investments to be equivalent to \$38000 at the time you withdraw from these accounts.
Not exactly, I said this above: Is the assumption that the \$3,800 paid in taxes on Roth, would have been invested in a Taxable account, so the growth would be equivalent? If so, expound on that for me.

By expound on that, what I mean is, show me how \$3,800 in a taxable account has the same tax equivalency over 30 years as \$3,800 in a tax-deferred 401k account. Taxable account incurs interest and dividends every year which will be taxed at different rates over time than the \$3,800 growing tax-deferred until withdrawal, no?
justsomeguy2018,

1) Why that \$3,800 cannot be invested in a Roth IRA?

2) Roth 401K should be compared with Trad. 401K with Roth IRAs.

3) Roth 401K will be a sure loser in that comparison.

KlangFool
Sure, but what if you are maxing out the Roth 401k and also maxing out the Roth IRA. Even after paying the \$3800 in taxes on the Roth 401k. The only place left for the \$3800 to go is in taxable, which will have a tax drag and not be equivalent.

FiveK
Posts: 8000
Joined: Sun Mar 16, 2014 2:43 pm

### Re: Help me with the Trad vs Roth 401k Math

justsomeguy2018 wrote:
Sat Feb 16, 2019 9:41 pm
Sure, but what if you are maxing out the Roth 401k and also maxing out the Roth IRA. Even after paying the \$3800 in taxes on the Roth 401k. The only place left for the \$3800 to go is in taxable, which will have a tax drag and not be equivalent.
And that's exactly what the wiki entry describes....

pdavi21
Posts: 1296
Joined: Sat Jan 30, 2016 4:04 pm

### Re: Help me with the Trad vs Roth 401k Math

You could just convert it to ROTH at some other time you had a lower rate.

The 19k Trad can become ROTH at anytime while it grows. The tax paid grows with the investment.
"We spend a great deal of time studying history, which, let's face it, is mostly the history of stupidity." -Stephen Hawking

lakpr
Posts: 3407
Joined: Fri Mar 18, 2011 9:59 am

### Re: Help me with the Trad vs Roth 401k Math

kaneohe wrote:
Sat Feb 16, 2019 9:38 pm
Assumptions have been that traditional is fully deductible. That may not always be true for some folks. That makes the case of lower tax rates later more complex.
Traditional 401k is deductible for everyone, not certain in what case the deductibility is phased out? Keep in mind the OP’s post did start off with assumption that the hypothetical tax rate is 20% on the contributions. The nearest tax brackets are 22% and 24% currently, and 25% tax bracket if we take 2017 tax rates; and for all folks in these brackets, 401k contributions are fully deductible.

FiveK
Posts: 8000
Joined: Sun Mar 16, 2014 2:43 pm

### Re: Help me with the Trad vs Roth 401k Math

lakpr wrote:
Sat Feb 16, 2019 9:44 pm
Traditional 401k is deductible for everyone, not certain in what case the deductibility is phased out?
There is no 401k deductibility phaseout.

Topic Author
justsomeguy2018
Posts: 310
Joined: Wed Oct 03, 2018 8:11 pm

### Re: Help me with the Trad vs Roth 401k Math

lakpr wrote:
Sat Feb 16, 2019 9:34 pm
Of course there will be a bit of tax drag on the \$3800 assumed to have been grown tenfold to \$38000. It will be slightly lower. For simplicity’s sake, assume 2.5% qualified dividends on the growth, taxes at 15% rate. The tax drag approximately would be (\$38000 - \$3800) * 0.025 * .15 = \$128

Edited to add: Klangfool makes an excellent point about why we aren’t considering the \$3800 to have been invested in a Roth IRA. But as my crude calculations above show, even if we did consider the amount to have been invested in the taxable account, the tax drag is minor.
A few issues with this: presumably the \$3800 should match the asset allocation in the 401k if the growth rates are equivalent. Yes if you have a 100% stock allocation that will be your tax rate, but not if you have x% in bonds or REIs as part of your AA.

Second, when you "draw down" the taxable account, the tax rate will be different (long-term capital gains rates) than drawing down a traditional 401k (taxed as ordinary income). Could be a positive or negative depending on your retirement annual income.

Third, your example of \$128 tax drag is for one year's worth of tax savings; I realize the math at this point could get pretty complicated and I have just been using made-up numbers, but whatever the tax drag is would have to account for each year's savings (for simplicity sake, multiple \$128 x 30). Still not a huge number but more than \$128 for sure.

So it still doesn't seem apples-to-apples comparison.

willthrill81
Posts: 15057
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

### Re: Help me with the Trad vs Roth 401k Math

justsomeguy2018 wrote:
Sat Feb 16, 2019 9:52 pm
lakpr wrote:
Sat Feb 16, 2019 9:34 pm
Of course there will be a bit of tax drag on the \$3800 assumed to have been grown tenfold to \$38000. It will be slightly lower. For simplicity’s sake, assume 2.5% qualified dividends on the growth, taxes at 15% rate. The tax drag approximately would be (\$38000 - \$3800) * 0.025 * .15 = \$128

Edited to add: Klangfool makes an excellent point about why we aren’t considering the \$3800 to have been invested in a Roth IRA. But as my crude calculations above show, even if we did consider the amount to have been invested in the taxable account, the tax drag is minor.
A few issues with this: presumably the \$3800 should match the asset allocation in the 401k if the growth rates are equivalent. Yes if you have a 100% stock allocation that will be your tax rate, but not if you have x% in bonds or REIs as part of your AA.

Second, when you "draw down" the taxable account, the tax rate will be different (long-term capital gains rates) than drawing down a traditional 401k (taxed as ordinary income). Could be a positive or negative depending on your retirement annual income.

Third, your example of \$128 tax drag is for one year's worth of tax savings; I realize the math at this point could get pretty complicated and I am using made-up numbers, but whatever the tax drag is would have to account for each year's savings (for simplicity sake, multiple \$128 x 30). Still not a huge number but more than \$128 for sure.

So it still doesn't seem apples-to-apples comparison.
You really need to input your numbers into the spreadsheet that FiveK linked to above. It takes all of that into account.

The simple answer is that tax-drag on a broad index fund like VTSAX isn't much. At the top tax brackets, it's only been .4% annually, and it would obviously be less than that in a lower tax bracket. Your marginal tax rate in retirement is the big variable; you might pay 0% long-term capital gains taxes then.

I suspect that maxing out the traditional 401k and investing the savings in a taxable account will win out compared to the Roth 401k.
Last edited by willthrill81 on Sat Feb 16, 2019 9:58 pm, edited 1 time in total.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

retire2022
Posts: 1025
Joined: Tue Oct 02, 2018 6:10 pm
Location: NYC

### Re: Help me with the Trad vs Roth 401k Math

op Social Security will be reduced or impacted under Traditional. Roth is a winner because your compounded profits are not taxed.

KlangFool
Posts: 14560
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Help me with the Trad vs Roth 401k Math

justsomeguy2018 wrote:
Sat Feb 16, 2019 9:41 pm
KlangFool wrote:
Sat Feb 16, 2019 9:30 pm
justsomeguy2018 wrote:
Sat Feb 16, 2019 9:20 pm
lakpr wrote:
Sat Feb 16, 2019 8:46 pm
You are conveniently (or in error) ignoring the \$3800 you paid in taxes now, which would grow at the same rate of investments to be equivalent to \$38000 at the time you withdraw from these accounts.
Not exactly, I said this above: Is the assumption that the \$3,800 paid in taxes on Roth, would have been invested in a Taxable account, so the growth would be equivalent? If so, expound on that for me.

By expound on that, what I mean is, show me how \$3,800 in a taxable account has the same tax equivalency over 30 years as \$3,800 in a tax-deferred 401k account. Taxable account incurs interest and dividends every year which will be taxed at different rates over time than the \$3,800 growing tax-deferred until withdrawal, no?
justsomeguy2018,

1) Why that \$3,800 cannot be invested in a Roth IRA?

2) Roth 401K should be compared with Trad. 401K with Roth IRAs.

3) Roth 401K will be a sure loser in that comparison.

KlangFool
Sure, but what if you are maxing out the Roth 401k and also maxing out the Roth IRA. Even after paying the \$3800 in taxes on the Roth 401k. The only place left for the \$3800 to go is in taxable, which will have a tax drag and not be equivalent.
justsomeguy2018,

There is a fundamental problem here. How much tax do you think someone with a taxable account, Roth IRA, and Trad. 401K will pay in the retirement? Especially, for someone with taxable account investment, they will most likely early retire.

My annual expense is 60K. I plan to early retire (before 62 years old) when I hit my number at 1.5 million. My portfolio is 45/45/10 (taxable/tax-deferred/Roth). I will keep about 2 years of expense in my emergency fund.

How much tax will I pay when I early retire? What do you think the answer will be?

KlangFool
Last edited by KlangFool on Sat Feb 16, 2019 10:02 pm, edited 1 time in total.

KlangFool
Posts: 14560
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Help me with the Trad vs Roth 401k Math

justsomeguy2018 wrote:
Sat Feb 16, 2019 9:52 pm
lakpr wrote:
Sat Feb 16, 2019 9:34 pm
Of course there will be a bit of tax drag on the \$3800 assumed to have been grown tenfold to \$38000. It will be slightly lower. For simplicity’s sake, assume 2.5% qualified dividends on the growth, taxes at 15% rate. The tax drag approximately would be (\$38000 - \$3800) * 0.025 * .15 = \$128

Edited to add: Klangfool makes an excellent point about why we aren’t considering the \$3800 to have been invested in a Roth IRA. But as my crude calculations above show, even if we did consider the amount to have been invested in the taxable account, the tax drag is minor.
A few issues with this: presumably the \$3800 should match the asset allocation in the 401k if the growth rates are equivalent. Yes if you have a 100% stock allocation that will be your tax rate, but not if you have x% in bonds or REIs as part of your AA.
justsomeguy2018,

KlangFool

Topic Author
justsomeguy2018
Posts: 310
Joined: Wed Oct 03, 2018 8:11 pm

### Re: Help me with the Trad vs Roth 401k Math

FiveK wrote:
Sat Feb 16, 2019 9:42 pm
justsomeguy2018 wrote:
Sat Feb 16, 2019 9:41 pm
Sure, but what if you are maxing out the Roth 401k and also maxing out the Roth IRA. Even after paying the \$3800 in taxes on the Roth 401k. The only place left for the \$3800 to go is in taxable, which will have a tax drag and not be equivalent.
And that's exactly what the wiki entry describes....
So it sounds like I may be correct? With the exception that, as someone else in the thread pointed out, sounds like the biggest variable would be whether you have to pay LTCG on the Taxable account withdrawals. That's helpful, and the kind of answer I was looking for.

lakpr
Posts: 3407
Joined: Fri Mar 18, 2011 9:59 am

### Re: Help me with the Trad vs Roth 401k Math

justsomeguy2018 wrote:
Sat Feb 16, 2019 9:52 pm
lakpr wrote:
Sat Feb 16, 2019 9:34 pm
Of course there will be a bit of tax drag on the \$3800 assumed to have been grown tenfold to \$38000. It will be slightly lower. For simplicity’s sake, assume 2.5% qualified dividends on the growth, taxes at 15% rate. The tax drag approximately would be (\$38000 - \$3800) * 0.025 * .15 = \$128

Edited to add: Klangfool makes an excellent point about why we aren’t considering the \$3800 to have been invested in a Roth IRA. But as my crude calculations above show, even if we did consider the amount to have been invested in the taxable account, the tax drag is minor.
A few issues with this: presumably the \$3800 should match the asset allocation in the 401k if the growth rates are equivalent. Yes if you have a 100% stock allocation that will be your tax rate, but not if you have x% in bonds or REIs as part of your AA.

Second, when you "draw down" the taxable account, the tax rate will be different (long-term capital gains rates) than drawing down a traditional 401k (taxed as ordinary income). Could be a positive or negative depending on your retirement annual income.

Third, your example of \$128 tax drag is for one year's worth of tax savings; I realize the math at this point could get pretty complicated and I have just been using made-up numbers, but whatever the tax drag is would have to account for each year's savings (for simplicity sake, multiple \$128 x 30). Still not a huge number but more than \$128 for sure.

So it still doesn't seem apples-to-apples comparison.
First two points are valid, it was an implicit assumption that the investments in all scenarios are identical. Now you are introducing additional variables where AA is different across taxable and tax deferred and Roth investments, the apples to apples comparison is already thrown out the window.

The \$128 tax drag is computed on the entire growth for simplicity, look at my calculations carefully. It includes taxes only on dividends, all are assumed to be qualified. I did not include capital gains taxes, that would be an additional (\$38000 - \$3800) * .15 = \$5130. I did not include this LTCG tax because we were only considering final balances without regard to taxes yet, or so I thought.

KlangFool
Posts: 14560
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Help me with the Trad vs Roth 401k Math

OP,

Someone with a taxable account, Roth IRA, Emergency Fund, Trad. 401K can do this.

A) Spend from the emergency fund and Roth IRA contribution -> this count as zero income.

B) Roth converts the Trad. 401K up to the standard deduction. This is taxed at 0%

C) Tax gain harvest or sell the taxable investment at the long-term capital gain tax rate of 0%.

Someone that are married can do this up to about 100K ((B) + (C) )per year. Aka, 0%.

Meanwhile, the Roth 401K person had paid 20+% taxes.

So, how could the Roth 401K's person win versus someone that pay 0%?

KlangFool

Topic Author
justsomeguy2018
Posts: 310
Joined: Wed Oct 03, 2018 8:11 pm

### Re: Help me with the Trad vs Roth 401k Math

lakpr wrote:
Sat Feb 16, 2019 10:03 pm
justsomeguy2018 wrote:
Sat Feb 16, 2019 9:52 pm
lakpr wrote:
Sat Feb 16, 2019 9:34 pm
Of course there will be a bit of tax drag on the \$3800 assumed to have been grown tenfold to \$38000. It will be slightly lower. For simplicity’s sake, assume 2.5% qualified dividends on the growth, taxes at 15% rate. The tax drag approximately would be (\$38000 - \$3800) * 0.025 * .15 = \$128

Edited to add: Klangfool makes an excellent point about why we aren’t considering the \$3800 to have been invested in a Roth IRA. But as my crude calculations above show, even if we did consider the amount to have been invested in the taxable account, the tax drag is minor.
A few issues with this: presumably the \$3800 should match the asset allocation in the 401k if the growth rates are equivalent. Yes if you have a 100% stock allocation that will be your tax rate, but not if you have x% in bonds or REIs as part of your AA.

Second, when you "draw down" the taxable account, the tax rate will be different (long-term capital gains rates) than drawing down a traditional 401k (taxed as ordinary income). Could be a positive or negative depending on your retirement annual income.

Third, your example of \$128 tax drag is for one year's worth of tax savings; I realize the math at this point could get pretty complicated and I have just been using made-up numbers, but whatever the tax drag is would have to account for each year's savings (for simplicity sake, multiple \$128 x 30). Still not a huge number but more than \$128 for sure.

So it still doesn't seem apples-to-apples comparison.
First two points are valid, it was an implicit assumption that the investments in all scenarios are identical. Now you are introducing additional variables where AA is different across taxable and tax deferred and Roth investments, the apples to apples comparison is already thrown out the window.

The \$128 tax drag is computed on the entire growth for simplicity, look at my calculations carefully. It includes taxes only on dividends, all are assumed to be qualified. I did not include capital gains taxes, that would be an additional (\$38000 - \$3800) * .15 = \$5130. I did not include this LTCG tax because we were only considering final balances without regard to taxes yet, or so I thought.
No, I am saying the AA is the same across all accounts. So the tax rate on the \$3800 wouldn't be exactly 15%, part of it would be taxed as bonds, unless your AA is 100%.

At any rate, after reading the Wiki and thinking it through some more, I think I am good now with the explanations and understand it a little better now.

Final thought: the math only works if you actually invest the \$3800 tax savings in similar growth investment, right? if you invest the \$3800 in a 2% Savings Account, e.g., then the Roth might still come out ahead, right?

Topic Author
justsomeguy2018
Posts: 310
Joined: Wed Oct 03, 2018 8:11 pm

### Re: Help me with the Trad vs Roth 401k Math

KlangFool wrote:
Sat Feb 16, 2019 10:09 pm
OP,

Someone with a taxable account, Roth IRA, Emergency Fund, Trad. 401K can do this.

A) Spend from the emergency fund and Roth IRA contribution -> this count as zero income.

B) Roth converts the Trad. 401K up to the standard deduction. This is taxed at 0%

C) Tax gain harvest or sell the taxable investment at the long-term capital gain tax rate of 0%.

Someone that are married can do this up to about 100K ((B) + (C) )per year. Aka, 0%.

Meanwhile, the Roth 401K person had paid 20+% taxes.

So, how could the Roth 401K's person win versus someone that pay 0%?

KlangFool
Those are valid points

willthrill81
Posts: 15057
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

### Re: Help me with the Trad vs Roth 401k Math

retire2022 wrote:
Sat Feb 16, 2019 9:58 pm
Roth is a winner because your compounded profits are not taxed.
Simple math shows this to be false.

Take \$10,000 deposited into a tax-deferred account, then doubled from returns. It's taxed at 10% in retirement. You'll be left with \$18,000 (\$10,000 x 2 X 90%).

Take \$9,000 (subjected to 10% income tax) deposited into a Roth account, then doubled that from returns. In retirement, it will be worth \$18,000 tax-free.

The key here is that the tax rate when the deposits and withdrawals were made was the same. If the tax rate when the contribution is made is higher than the withdrawal tax rate, the tax-deferred account will end up with more, and vice versa for the Roth account.

Yes, Social Security and other income streams can complicate the issue, but the basic idea of tax arbitrage is the primary driver of when type of account to use.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

KlangFool
Posts: 14560
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Help me with the Trad vs Roth 401k Math

justsomeguy2018 wrote:
Sat Feb 16, 2019 10:14 pm

Final thought: the math only works if you actually invest the \$3800 tax savings in similar growth investment, right? if you invest the \$3800 in a 2% Savings Account, e.g., then the Roth might still come out ahead, right?
justsomeguy2018,

The Roth investment could be a 2% saving account too.

KlangFool

KlangFool
Posts: 14560
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Help me with the Trad vs Roth 401k Math

OP,

I hope you get the point.

A) The Roth 401K person paid full marginal tax rate. He cannot get the money back from the IRS.

B) The Trad. 401K + Roth IRA+ taxable account person has maximum tax diversity. He could choose how much taxes to pay at any point in time. And, depending on how well he played the game. He could come up significant ahead.

For many of us with large taxable investment, besides no tax-drag, we use tax loss harvesting to deduct \$3,000 from our taxable income every year. You cannot do this if you go with Roth 401K.

KlangFool

willthrill81
Posts: 15057
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

### Re: Help me with the Trad vs Roth 401k Math

KlangFool wrote:
Sat Feb 16, 2019 10:39 pm
The Trad. 401K + Roth IRA+ taxable account person has maximum tax diversity. He could choose how much taxes to pay at any point in time. And, depending on how well he played the game. He could come up significant ahead.

I've heard several financial planners and accountants say that their clients would be significantly better off if their clients had taken such a route so that they had some choice as to where to pull their income from in a given year.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

JBTX
Posts: 5712
Joined: Wed Jul 26, 2017 12:46 pm

### Re: Help me with the Trad vs Roth 401k Math

justsomeguy2018 wrote:
Sat Feb 16, 2019 10:14 pm
lakpr wrote:
Sat Feb 16, 2019 10:03 pm
justsomeguy2018 wrote:
Sat Feb 16, 2019 9:52 pm
lakpr wrote:
Sat Feb 16, 2019 9:34 pm
Of course there will be a bit of tax drag on the \$3800 assumed to have been grown tenfold to \$38000. It will be slightly lower. For simplicity’s sake, assume 2.5% qualified dividends on the growth, taxes at 15% rate. The tax drag approximately would be (\$38000 - \$3800) * 0.025 * .15 = \$128

Edited to add: Klangfool makes an excellent point about why we aren’t considering the \$3800 to have been invested in a Roth IRA. But as my crude calculations above show, even if we did consider the amount to have been invested in the taxable account, the tax drag is minor.
A few issues with this: presumably the \$3800 should match the asset allocation in the 401k if the growth rates are equivalent. Yes if you have a 100% stock allocation that will be your tax rate, but not if you have x% in bonds or REIs as part of your AA.

Second, when you "draw down" the taxable account, the tax rate will be different (long-term capital gains rates) than drawing down a traditional 401k (taxed as ordinary income). Could be a positive or negative depending on your retirement annual income.

Third, your example of \$128 tax drag is for one year's worth of tax savings; I realize the math at this point could get pretty complicated and I have just been using made-up numbers, but whatever the tax drag is would have to account for each year's savings (for simplicity sake, multiple \$128 x 30). Still not a huge number but more than \$128 for sure.

So it still doesn't seem apples-to-apples comparison.
First two points are valid, it was an implicit assumption that the investments in all scenarios are identical. Now you are introducing additional variables where AA is different across taxable and tax deferred and Roth investments, the apples to apples comparison is already thrown out the window.

The \$128 tax drag is computed on the entire growth for simplicity, look at my calculations carefully. It includes taxes only on dividends, all are assumed to be qualified. I did not include capital gains taxes, that would be an additional (\$38000 - \$3800) * .15 = \$5130. I did not include this LTCG tax because we were only considering final balances without regard to taxes yet, or so I thought.
No, I am saying the AA is the same across all accounts. So the tax rate on the \$3800 wouldn't be exactly 15%, part of it would be taxed as bonds, unless your AA is 100%.

At any rate, after reading the Wiki and thinking it through some more, I think I am good now with the explanations and understand it a little better now.

Final thought: the math only works if you actually invest the \$3800 tax savings in similar growth investment, right? if you invest the \$3800 in a 2% Savings Account, e.g., then the Roth might still come out ahead, right?
Probably.

It really comes down to assumptions. If your retirement marginal rate is 10% less, traditional will be better assuming you invest the upfront traditional tax savings elsewhere. If you are maxing your 401k, then the traditional tax saving would go into a taxable account using comparable funds and allocations. Since the tax savings are going into a taxable account, the long term returns will be a little bit lower, and that eats into that 10% marginal tax rate advantage a bit.

For a disciplined and educated Boglehead type investor keeping the traditional tax savings invested for several decades in a taxable account until retirement may be a reasonable assumption. But it might not be a good assumption for most "normal" investors. That tax savings may be spent on consumption, or invested in a house, or used to pay off a low rate mortgage.

There are many qualitative advantages to the Roth. You don't have to worry about tax gain or tax loss harvesting. Rebalancing is somewhat easier as you don't have to worry about capital gain realization. A retirement tax advantaged account tends to viewed as less accessible than a taxable account. You don't have to worry about taxable RMDs. You don't have to worry about tax ability of social security as it relates to RMDs. You don't have to worry about "stacking" issues of realized capital gains and rmds/traditional withdrawals. You don't have to worry about future tax increases.

If you aren't one to spend all of your rmds, depending on your portfolio, those funds post RMD will now be in a taxable account, whereas a roth stays tax advantaged.

So how much are all those intangibles worth in terms of marginal tax rate differential? Easily a few points. Maybe more. It is hard to quantify.

FiveK
Posts: 8000
Joined: Sun Mar 16, 2014 2:43 pm

### Re: Help me with the Trad vs Roth 401k Math

justsomeguy2018 wrote:
Sat Feb 16, 2019 10:03 pm
FiveK wrote:
Sat Feb 16, 2019 9:42 pm
justsomeguy2018 wrote:
Sat Feb 16, 2019 9:41 pm
Sure, but what if you are maxing out the Roth 401k and also maxing out the Roth IRA. Even after paying the \$3800 in taxes on the Roth 401k. The only place left for the \$3800 to go is in taxable, which will have a tax drag and not be equivalent.
And that's exactly what the wiki entry describes....
So it sounds like I may be correct?

JustinR
Posts: 1140
Joined: Tue Apr 27, 2010 11:43 pm

### Re: Help me with the Trad vs Roth 401k Math

This doesn't address your math problem, but with a traditional 401k you can literally pay 0% taxes on it from contribution to withdrawal (through Roth conversions). You can't do that with a Roth 401k.

Roth is a loser compared to traditional.

ralph124cf
Posts: 2389
Joined: Tue Apr 01, 2014 11:41 am

### Re: Help me with the Trad vs Roth 401k Math

An advantage of ROTH in retirement that has not been mentioned here yet: IRMAA. Those with moderately high income over 65 must pay higher Medicare "fees" (not an income tax, it says so in the definition), based on AGI. Federal income-tax-free municipal bond interest counts for AGI in this case, but ROTH withdrawals do not.

Most people over 65 pay \$134/month for Medicare part B. Higher income people must pay higher fees, (not an income tax, just a higher fee paid to the US government) of up to \$428/month, per person. This is over \$7,000 per year extra for a married couple filing jointly. Using ROTH instead of traditional IRA can avoid this (not-an-income-tax) fee, at least under current law.

Ralph

TomatoTomahto
Posts: 9737
Joined: Mon Apr 11, 2011 1:48 pm

### Re: Help me with the Trad vs Roth 401k Math

JBTX wrote:
Sat Feb 16, 2019 10:45 pm
For a disciplined and educated Boglehead type investor keeping the traditional tax savings invested for several decades in a taxable account until retirement may be a reasonable assumption. But it might not be a good assumption for most "normal" investors. That tax savings may be spent on consumption, or invested in a house, or used to pay off a low rate mortgage.
There are many qualitative advantages to the Roth. You don't have to worry about tax gain or tax loss harvesting. Rebalancing is somewhat easier as you don't have to worry about capital gain realization. A retirement tax advantaged account tends to viewed as less accessible than a taxable account. You don't have to worry about taxable RMDs. You don't have to worry about tax ability of social security as it relates to RMDs. You don't have to worry about "stacking" issues of realized capital gains and rmds/traditional withdrawals. You don't have to worry about future tax increases.
If you aren't one to spend all of your rmds, depending on your portfolio, those funds post RMD will now be in a taxable account, whereas a roth stays tax advantaged.
So how much are all those intangibles worth in terms of marginal tax rate differential? Easily a few points. Maybe more. It is hard to quantify.
Thank you for listing the “intangibles,” although, as we approach the age of 70.5, they’re becoming more tangible

Posters always refer to the initial RMD of less than 4%. But, by age 80, it’s more than 5%, and by 86, it’s more than 7%.

I have gone around in circles about putting my wife’s 401k into a Roth. My comfort is that, at worst I’m making a few percent mistake in tax calculations and at best, I have found a refuge from the drag of taxes on my heirs’ money. My regret is not doing this years ago.
Okay, I get it; I won't be political or controversial. The Earth is flat.

welderwannabe
Posts: 1113
Joined: Fri Jun 16, 2017 8:32 am

### Re: Help me with the Trad vs Roth 401k Math

I don't want to hit the third rail of politics here, but tax rates are pretty low right now. Are they going to stay this low forever? I don't think so.

Therefore I have started to split my contributions 50% ROTH 50% Traditional.
I am not an investment professional, but I did stay at a Holiday Inn Express last night.

rkhusky
Posts: 7820
Joined: Thu Aug 18, 2011 8:09 pm

### Re: Help me with the Trad vs Roth 401k Math

justsomeguy2018 wrote:
Sat Feb 16, 2019 10:14 pm
Final thought: the math only works if you actually invest the \$3800 tax savings in similar growth investment, right? if you invest the \$3800 in a 2% Savings Account, e.g., then the Roth might still come out ahead, right?
That's definitely not an apple to apple comparison. The reverse is also true - if you put the Roth in a MM account and invest taxable in Total Stock Market, Roth probably does much worse.

If you are maxing all tax-advantaged accounts and your contribution and withdrawal rates are the same, then Roth is better than Traditional due to taxable tax drag. For my situation, I computed the drag to be worth about 3-5%. So, in the OP example, where the difference between contribution and withdrawal tax rates is 10%, Traditional is still better.

Topic Author
justsomeguy2018
Posts: 310
Joined: Wed Oct 03, 2018 8:11 pm

### Re: Help me with the Trad vs Roth 401k Math

rkhusky wrote:
Sun Feb 17, 2019 8:15 am
justsomeguy2018 wrote:
Sat Feb 16, 2019 10:14 pm
Final thought: the math only works if you actually invest the \$3800 tax savings in similar growth investment, right? if you invest the \$3800 in a 2% Savings Account, e.g., then the Roth might still come out ahead, right?
That's definitely not an apple to apple comparison. The reverse is also true - if you put the Roth in a MM account and invest taxable in Total Stock Market, Roth probably does much worse.
Sorry my point may not have been very clear - as someone else mentioned earlier in this thread, I am skeptical most people have the discipline to say "Hey this \$x tax dollars I am saving from Traditional, I am going to invest it in a taxable account at the same AA/growth rate as my Traditional to be sure I come out ahead vs if I had invested in Roth instead, and to ensure I capitalize on my lower tax rate in retirement vs current Roth tax rate"

So, if instead, the extra tax savings money just sits in a 2% yield savings account (full disclosure: I am currently doing this for now, but not for long), then the math does not necessarily work out that the Traditional still beats the Roth (assuming the market can soundly beat a 2% return or whatever the yield in the savings account is). And depending on what the Roth growth rate ends up being and the overall differences in pre and post retirement rates (in my example I used 10x growth rate and 10% vs 20% tax rate; a 2x growth rate and 10% vs 25% tax rate would not yield same conclusion).

nick evets
Posts: 249
Joined: Wed Mar 01, 2017 5:40 pm

### Re: Help me with the Trad vs Roth 401k Math

KlangFool wrote:
Sat Feb 16, 2019 10:09 pm

A) Spend from the emergency fund and Roth IRA contribution -> this count as zero income.

B) Roth converts the Trad. 401K up to the standard deduction. This is taxed at 0%

C) Tax gain harvest or sell the taxable investment at the long-term capital gain tax rate of 0%.

KlangFool
Don't want to derail, but how is it possible to convert from a traditional 401k to a Roth w/out paying Federal income tax?

Topic Author
justsomeguy2018
Posts: 310
Joined: Wed Oct 03, 2018 8:11 pm

### Re: Help me with the Trad vs Roth 401k Math

nick evets wrote:
Sun Feb 17, 2019 9:01 am
KlangFool wrote:
Sat Feb 16, 2019 10:09 pm

A) Spend from the emergency fund and Roth IRA contribution -> this count as zero income.

B) Roth converts the Trad. 401K up to the standard deduction. This is taxed at 0%

C) Tax gain harvest or sell the taxable investment at the long-term capital gain tax rate of 0%.

KlangFool
Don't want to derail, but how is it possible to convert from a traditional 401k to a Roth w/out paying Federal income tax?
I am not 100% sure but I think it is based on converting \$24,000 (current standard deduction amount) and assuming no additional income (e.g. perhaps using Roth or savings for that year's expenses).

The thought is you ladder these, so that every 5-years you have Roth monies available and pay no tax on the conversion. Pretty interesting stuff really.

kaneohe
Posts: 6017
Joined: Mon Sep 22, 2008 12:38 pm

### Re: Help me with the Trad vs Roth 401k Math

nick evets wrote:
Sun Feb 17, 2019 9:01 am
KlangFool wrote:
Sat Feb 16, 2019 10:09 pm

A) Spend from the emergency fund and Roth IRA contribution -> this count as zero income.

B) Roth converts the Trad. 401K up to the standard deduction. This is taxed at 0%

C) Tax gain harvest or sell the taxable investment at the long-term capital gain tax rate of 0%.

KlangFool
Don't want to derail, but how is it possible to convert from a traditional 401k to a Roth w/out paying Federal income tax?
have no other income ......or low enough income that adding the conversion is still below your deduction .

nick evets
Posts: 249
Joined: Wed Mar 01, 2017 5:40 pm

### Re: Help me with the Trad vs Roth 401k Math

Whoa...that IS interesting. Thanks all -- I'm not sure my wife and I would be able to live for a year, yet, w/out taxable income, but the idea is cool. Please forgive the interruption.

rkhusky
Posts: 7820
Joined: Thu Aug 18, 2011 8:09 pm

### Re: Help me with the Trad vs Roth 401k Math

justsomeguy2018 wrote:
Sun Feb 17, 2019 8:59 am
Sorry my point may not have been very clear - as someone else mentioned earlier in this thread, I am skeptical most people have the discipline to say "Hey this \$x tax dollars I am saving from Traditional, I am going to invest it in a taxable account at the same AA/growth rate as my Traditional to be sure I come out ahead vs if I had invested in Roth instead, and to ensure I capitalize on my lower tax rate in retirement vs current Roth tax rate"

So, if instead, the extra tax savings money just sits in a 2% yield savings account (full disclosure: I am currently doing this for now, but not for long), then the math does not necessarily work out that the Traditional still beats the Roth (assuming the market can soundly beat a 2% return or whatever the yield in the savings account is). And depending on what the Roth growth rate ends up being and the overall differences in pre and post retirement rates (in my example I used 10x growth rate and 10% vs 20% tax rate; a 2x growth rate and 10% vs 25% tax rate would not yield same conclusion).
Most people probably just spend their tax savings. So, for those people who need to be forced to save, then Roth is better. They probably also over-contribute to their taxes so they get a big refund. If that is what it takes to save, they should go for it, even if it is sub-optimal.

KlangFool
Posts: 14560
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Help me with the Trad vs Roth 401k Math

nick evets wrote:
Sun Feb 17, 2019 9:25 am
Whoa...that IS interesting. Thanks all -- I'm not sure my wife and I would be able to live for a year, yet, w/out taxable income, but the idea is cool. Please forgive the interruption.
nick evets,

A) If you early retire, you should keep 1 to 2 years of the emergency fund. So, if you only spend from your emergency fund, what is your taxable income? Aka, spending cash.

B) If you are married, you have 10K to 12K of Roth IRA contribution every year. After 10 to 20 years, you have 100K to 200K worth of IRA contribution that you can spend without generating taxable income. So, how many years can you live on 100K to 200K worth of Roth IRA's contribution?

KlangFool

KlangFool
Posts: 14560
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Help me with the Trad vs Roth 401k Math

rkhusky wrote:
Sun Feb 17, 2019 9:48 am
justsomeguy2018 wrote:
Sun Feb 17, 2019 8:59 am
Sorry my point may not have been very clear - as someone else mentioned earlier in this thread, I am skeptical most people have the discipline to say "Hey this \$x tax dollars I am saving from Traditional, I am going to invest it in a taxable account at the same AA/growth rate as my Traditional to be sure I come out ahead vs if I had invested in Roth instead, and to ensure I capitalize on my lower tax rate in retirement vs current Roth tax rate"

So, if instead, the extra tax savings money just sits in a 2% yield savings account (full disclosure: I am currently doing this for now, but not for long), then the math does not necessarily work out that the Traditional still beats the Roth (assuming the market can soundly beat a 2% return or whatever the yield in the savings account is). And depending on what the Roth growth rate ends up being and the overall differences in pre and post retirement rates (in my example I used 10x growth rate and 10% vs 20% tax rate; a 2x growth rate and 10% vs 25% tax rate would not yield same conclusion).
Most people probably just spend their tax savings. So, for those people who need to be forced to save, then Roth is better. They probably also over-contribute to their taxes so they get a big refund. If that is what it takes to save, they should go for it, even if it is sub-optimal.
rkhusky,

If those people do a Trad. 401K and Roth IRA combination, they still save and invest money.

KlangFool

KlangFool
Posts: 14560
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Help me with the Trad vs Roth 401k Math

justsomeguy2018 wrote:
Sun Feb 17, 2019 8:59 am
rkhusky wrote:
Sun Feb 17, 2019 8:15 am
justsomeguy2018 wrote:
Sat Feb 16, 2019 10:14 pm
Final thought: the math only works if you actually invest the \$3800 tax savings in similar growth investment, right? if you invest the \$3800 in a 2% Savings Account, e.g., then the Roth might still come out ahead, right?
That's definitely not an apple to apple comparison. The reverse is also true - if you put the Roth in a MM account and invest taxable in Total Stock Market, Roth probably does much worse.
Sorry my point may not have been very clear - as someone else mentioned earlier in this thread, I am skeptical most people have the discipline to say "Hey this \$x tax dollars I am saving from Traditional, I am going to invest it in a taxable account at the same AA/growth rate as my Traditional to be sure I come out ahead vs if I had invested in Roth instead, and to ensure I capitalize on my lower tax rate in retirement vs current Roth tax rate"
justsomeguy2018,

This is a strawman that you created in order to support your point. The best combination is Trad. 401K and Roth IRAs. If someone can save beyond that, they are not normal people. Then, you do not need to worry about their discipline of investing in the taxable account.

For a single Trad. 401K + 2 X Roth IRAs = 19K + 12K = 31K
2 X 401K + 2 Roth IRAs = 38K + 12K = 50K

KlangFool

willthrill81
Posts: 15057
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

### Re: Help me with the Trad vs Roth 401k Math

nick evets wrote:
Sun Feb 17, 2019 9:25 am
Whoa...that IS interesting. Thanks all -- I'm not sure my wife and I would be able to live for a year, yet, w/out taxable income, but the idea is cool.
Many, probably most, of those who employ this strategy have significant taxable accounts as well. These can provide significant tax-free income (remember that long-term capital gains taxes can be 0%) while you're doing Roth conversions.

Using a combination of filling up the standard deduction with withdrawals from tax-deferred accounts, paying for medical expenses tax-free via HSA withdrawals, and covering the rest with withdrawals from taxable and Roth accounts, it's pretty easy to craft a realistic scenario where a married-filing-jointly couple has \$100k of income in retirement that they pay no taxes on at all.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

KlangFool
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### Re: Help me with the Trad vs Roth 401k Math

willthrill81 wrote:
Sun Feb 17, 2019 10:43 am
nick evets wrote:
Sun Feb 17, 2019 9:25 am
Whoa...that IS interesting. Thanks all -- I'm not sure my wife and I would be able to live for a year, yet, w/out taxable income, but the idea is cool.
Many, probably most, of those who employ this strategy have significant taxable accounts as well. These can provide significant tax-free income (remember that long-term capital gains taxes can be 0%) while you're doing Roth conversions.

Using a combination of filling up the standard deduction with withdrawals from tax-deferred accounts, paying for medical expenses tax-free via HSA withdrawals, and covering the rest with withdrawals from taxable and Roth accounts, it's pretty easy to craft a realistic scenario where a married-filing-jointly couple has \$100k of income expense in retirement that they pay no taxes on at all.
willthrill81,

I would like to change one word in your post.

KlangFool