Traditional versus Roth

From Bogleheads

Traditional versus Roth refers to the common investment decision of whether to use traditional (pre-tax) or Roth accounts. You must make this decision when your employer offers both a traditional and Roth 401(k), or when you can deduct a traditional IRA contribution or use a Roth IRA, or when you consider leaving money in a traditional account or converting some to Roth.

The better option is the one that gives you (or your heirs, if you are estate planning) more spendable income after all taxes are paid. Preference for one account type or the other is fundamentally a tax planning question.

In a traditional retirement account such as a deductible traditional IRA or traditional 401(k), your contributions are deductible - no tax is paid on account growth while the money remains in the account, and withdrawals are taxed as ordinary income.

In a Roth retirement account such as a Roth IRA or Roth 401(k), your contributions are not deductible, but all future growth and withdrawals are tax-free in retirement.[1][2]

The approach that incurs a lower marginal tax rate will, in most cases, provide you more spendable income. Neither is inherently better, as either one may be a better choice in different situations. Here are some of the considerations.

General guidelines

See Prioritizing investments for general investment considerations.

The decision between deductible traditional vs. Roth contributions hinges primarily on a comparison between your known marginal tax rate now vs. an estimated marginal tax rate at withdrawal. As discussed in more detail below, estimating future marginal tax rates relies on a lot of assumptions and tax brackets and rules can change at any time.

Assuming you have an estimate for your future marginal tax rate, prefer traditional when your current marginal rate is higher than that estimate, and prefer Roth when your current marginal rate is lower than the estimate.

Those who choose not to estimate future tax rates are left with various rules of thumb for guidance. Because these rules of thumb have many exceptions, a personalized future estimate is recommended, but in lieu of that consider:

  • Contributing 100% traditional, because it is the best choice for most people most of the time
  • Contributing 50% traditional and 50% Roth, because a mix adds tax diversification and you cannot be more than 50% wrong
  • Contributing according to some rules of thumb that might be applicable, although most of them still require some assumption about future tax rates.

For those reluctant to contribute at all, either traditional or Roth, or any mix, is almost always a better choice than saving outside retirement accounts. In addition to providing more future income after taxes, traditional and Roth accounts also offer other benefits such as asset protection and estate planning.

Whatever you choose for any one year, you may make a different choice in subsequent years.

Eligibility

Not all investors will be able to choose between traditional and Roth options in all their accounts.

Employer-sponsored accounts (401(k), 403(b), 457(b)) always offer a traditional option, but may or may not offer a Roth option. However, there are no income limitations on contributions, as there are for IRAs.

With IRAs, the eligibility of traditional vs. Roth is affected by income. There is an income limit for deducting contributions to a traditional IRA. Above that limit, and below the Roth IRA contribution income limit, a Roth IRA is best. Above the Roth IRA income contribution limit, you may choose either the backdoor Roth IRA contribution process, a Non-deductible traditional IRA, or a taxable account- see those pages for more details.

See also: Comparison between IRAs and employer plans.

Common misconceptions

There are two common misconceptions, one that incorrectly favors traditional, and one that incorrectly favors Roth.

The first misconception is sometimes described as "contributions are taken from the top tax rate and are withdrawn later at the average rate". In other words, that you save a marginal rate when contributing but pay only an average rate (starting at 0% for the first dollar withdrawn) when withdrawing. Following is an example of why that is not true.

Consider a 50 year old who has already accumulated a $500K traditional balance. Even without any further contributions, that could reasonably double to $1 million by age 65. Taking a 4%/yr withdrawal then gives $40K/yr. Any traditional contributions at age 51 (or later) will increase the traditional balance at age 65, thus allowing more than $40K/yr withdrawal. The taxation on the amount above $40K/yr will occur at the marginal rate on that amount, not the effective rate on the total income.

The second misconception is that "it is better to pay tax on the seed than the harvest." In other words, that it is better to pay a lesser tax amount now to make a Roth contribution, instead of a larger amount of tax later on a traditional withdrawal. This is not true because taking a percentage of the "seed" is the same as letting the full seed grow and then taking the same percentage of the "harvest." The result will be the same in either case.

The goal should not be to pay as little tax as possible. Instead, the goal should be to have as much money leftover after taxes as possible. Comparing marginal rates between contribution (or conversion now) and withdrawal in the future is the most direct way to achieve this goal.

Calculations

The main reason to prefer one type of account over the other is the difference between current vs. future marginal tax rates.

Simplest situation

For the same pre-tax contribution amount and growth, the after-tax value is entirely determined by the marginal tax rate on contributions and withdrawals. This also applies to "now vs. later" Roth conversions when the tax is paid from converted funds. For Roth conversions, in the discussion below read "traditional" as "convert later" and "Roth" as "convert now".

You can calculate the amount you get after taxes as:

The "Growth factor" can be calculated as (1 + r)^t, where r is the annual rate of return and t is the time in years. Because you may choose identical investments in both traditional and Roth accounts, the "Growth factor" is the same for each.

If the marginal tax rate now (the "contribution tax rate") is higher than the marginal tax rate later (the "withdrawal tax rate"), then the traditional account is better; if it is lower, then the Roth account is better. For the Roth conversion decision, "traditional account is better" means "do not convert" and "Roth account is better" means "do convert".

When the withdrawal marginal tax rate will be the same as the marginal tax rate saved by a traditional contribution), thanks to the commutative property of multiplication (i.e., A * B * C = A * C * B) the traditional and Roth results are equal.

More complicated situations

The simple analysis above is valid for many situations, but it does make assumptions that are not applicable in other situations. Those other situations include

"Traditional plus taxable" vs. Roth

For an apples-to-apples comparison, you must sometimes compare Roth accounts against a combination of traditional and taxable accounts. This situation occurs in three different ways:[note 1]

a) Contributing more to a Roth than the after-tax amount of the maximum traditional contribution, e.g., when contributing the maximum to retirement accounts.
b) Doing a Roth conversion and paying the conversion tax from cash on hand (as opposed to paying the tax from the conversion amount).
c) Doing a Roth conversion to reduce required minimum distributions (RMDs) when the RMDs will be invested in a taxable account instead of spent.

In these situations, tax drag in the taxable account may make Roth preferable even if the withdrawal tax rate is somewhat below the contribution tax rate. Examples of "somewhat" are shown in a table below for situations a) and b), and there are two spreadsheets that will calculate "somewhat" for specific circumstances in those situations:[3]

Situation c) is even more complicated because, unlike for a) and b), a single equation for that situation has not been derived and a year-by-year spreadsheet approach is the best available. Two spreadsheets that have been published for this use are

Niche situations

If you are in either of the situations below, follow the links for details and simple calculations.

Regardless of whether you have a simple or more complicated situation, you generally need values for both current and future marginal rates to make a reasoned choice. How to get those values comes next.

There is one notable shortcut: If you can contribute to Roth accounts today at 12% or less, it is usually a good idea as this is a historically low tax rate - especially if you are far from retirement. Many things can change that could cause you to pay a higher rate at withdrawal; such as changes in tax law, moving to a higher-tax state, unexpected increases in income, inheriting an IRA, among others. Only defer taxes at 12% or less if you are close to withdrawal and are very confident you will be able to withdraw at a lower rate.

Calculating marginal tax rate now

Your marginal tax rate now is relatively easy to determine. It is not necessarily your tax bracket, because of phase-ins and phase-outs of tax benefits (e.g., business tax considerations, various credits, Taxation of Social Security benefits), and tax-like costs (e.g., Expected Family Contribution, ACA Health Insurance, and IRMAA Medicare premium surcharges); see Marginal tax rate for a more detailed explanation, and Traditional versus Roth examples for examples.

You can use your favorite Tax estimation tool to calculate the tax change for the maximum contribution or conversion amount considered. If the (change in tax) divided by (change in income) does match one of the nominal tax brackets (e.g., 12%, 22%, 24%, etc.), that is all you need to know. If you get a different answer, more work is needed: using small ($100 or so) changes in income to determine at what point(s) (change in tax) divided by (change in income) gets a new result. This can be done by hand, or using a tool such as the Personal finance toolbox that will provide answers in chart form.

Estimating future marginal tax rate

Estimating your future marginal tax rate is considerably harder than for today, and high accuracy should not be expected. There are two parts to the estimate: 1) your taxable income, and 2) how tax law will treat that income. While both parts may have high uncertainty, great precision is usually not needed to make a reasonable estimate.

For future tax law, using this year's version is generally recognized as a good starting point, but if you have strong feelings for how tax rates and laws will change in the future, you could make your own calculations. If you are willing to use this year's law, follow the procedure in Calculating marginal tax rate now but use your estimated future income, filing status, number of dependents, etc.

There are many methods to estimate future income. Below are two, labeled as "simple" and "detailed". Those looking to retire early and expect their future taxable income will be predominantly from pre-tax withdrawals (i.e., little-to-no pension income, dividends, Social Security, etc.) might benefit from a simpler method. Those closer to retirement, or in a career characterized by long periods of low-income training followed by much higher earnings, might benefit from a more detailed method. As with many things, the method Should Be Made as Simple as Possible, But Not Simpler.

Whatever method you use:

  • To be consistent with using today's tax rates you should ignore inflation by using real expected rates of return instead of nominal returns for investment growth.
  • The more conservative your estimates (rates of return, career length, number and size of other retirement income streams, withdrawal rates, etc.), the more likely "use traditional now" will be the answer, and vice versa. Whether those answers will have been correct, only time will tell, because we do not know whether "conservative" or "optimistic" will have been "correct".

Simple method

Use

One can do this quickly on any calculator (hand-held, Windows, etc.) that does exponents (e.g., the xy button on the Windows calculator).

In this equation,

r = Real rate of return on pre-tax investments, %
t = Number of years until withdrawals start (e.g., at retirement)
WR = Withdrawal rate from pre-tax accounts, %/yr

Reasonable guesses for r, t, and WR can vary widely within (and even outside) the following ranges:

r - from 2% to 6% (depends on market behavior and asset allocation within the pre-tax accounts)
t - from 0 to ? (very dependent on individual circumstances)
WR - from 3% (e.g., those who think the “4% rule” is optimistic) to 8% (e.g., those who want to reduce pre-tax balances before starting Social Security and Required Minimum Distributions)

For example, with current pre-tax balance = $375K, r = 4%, t = 25 years, and WR = 5%, Future annual income = $50K/yr in today's dollars. The federal tax bracket for $50K/yr Adjusted Gross Income (AGI) using current tax law is 12%. What the marginal rate will be depends on all the taxpayer's circumstances.

For comparison, if you assume

r = 2%, t = 20 years, and WR = 3%, Future annual income = $17K/yr
r = 6%, t = 30 years, and WR = 7%, Future annual income = $151K/yr

In other words, changed assumptions can produce very different results, so take a best guess now and update annually.

You could also choose to assume that some future annual contributions to traditional accounts will be made, for the purpose of deciding whether to make a traditional contribution this year. See the Pre-tax withdrawals section in the detailed method for using a spreadsheet function to do that.

Detailed method

A more detailed analysis may give a better answer, but is also more complex to perform. Assumptions about contribution type in the current year, and similar future years, affect the predictions for future income and tax rates, so more than one iteration may be required. See below for a method to estimate each common type of future income.

Pre-tax withdrawals

If you plan for the current year to be about the same financially as every year between now and withdrawal, the Future Value function ("=FV" in Excel) is useful for estimating future income:


In this equation,

r = Expected real rate of return on pre-tax investments, %
t = Number of years until withdrawals start (e.g., at retirement)
c = Planned annual pre-tax contributions, including employer contributions/match
b = Current aggregate pre-tax balance
WR = Withdrawal rate from pre-tax accounts, %/yr

If your plan is more complex, involving contributions changing in future years (eg. income expected to rise, catch-up contributions after age 50, large Roth conversions before age 70-72, etc.) then a more complex estimate using a spreadsheet may be needed.

Note that this estimate requires an expected pattern of traditional contributions. Begin with a "guess", which can be taken from the list of typical cases, or a prior year's analysis. If, at the end, this "guess" looks to be the wrong choice, you may need to revise that estimate and repeat the analysis.

Taxable investments

Investors with significant taxable accounts should account for yield income (interest, dividends, capital gains distributions) from these investments. At a minimum, the expected yield from taxable investments is:


In this equation,

r = Expected real rate of return on taxable investments, %
y = Expected yield from investments, %
= Average tax rate on investment yield
t = Number of years until withdrawals start (e.g., at retirement)
c = Planned annual taxable contributions
b = Current aggregate taxable balance

If you plan on taking taxable withdrawals, the additional capital gains should also be included.

For a portfolio of mostly passive stock-based mutual funds, a yield of 2% is a reasonable estimate. Bonds and bond-based funds tend to yield higher, so this number should be adjusted upward if your taxable portfolio has a significant bond allocation.

Note that qualified dividends and long-term capital gains are taxed at reduced rates, and these forms of income stack "on top" of other income that is taxed at ordinary rates. So, this income may have little effect on your marginal tax rate for pre-tax withdrawals. However, qualified dividends and long-term capital gains are taken into account for taxation of Social Security benefits, and can add marginal rate to pre-tax withdrawals if the latter shifts the former up into a higher bracket.

Social Security

If you plan to retire near the age when you expect Social Security payments will begin, include the expected payment, in the percentage that will be taxable according to the laws for taxation of Social Security benefits.

Note that taxation of Social Security benefits phases in at a rate of either 50% or 85% for each dollar of other income. Therefore, if your total income is in the phase-in range, you can expect a marginal tax rate 1.5x or 1.85x your tax bracket. Typical planning strategies are to come in either just below, or far above, this rate "spike." If your plan has your income around this spike, reconsider your choice of contribution type and rerun the analysis if necessary. An example of this planning is shown below.

Several online tools exist for estimating your future Social Security benefit, on the Social Security Administration (SSA) website and elsewhere.

Other income

Include any other expected forms of taxable income, such as a pension, income from part-time work, royalties, inherited traditional distributions, rental property income not expected to be sheltered by depreciation, etc.

Standard deduction

As of 2024, the standard deduction is $16,550 (single) or $32,300 (married filing jointly) for taxpayers age 65 and older, or $14,600 (single) or $29,200 (married filing jointly) for taxpayers under age 65. Subtract the most appropriate value from your expected future income.

It is uncommon (but not impossible) for retirees to itemize deductions, so assuming the standard deduction is usually safe. If you expect to itemize deductions, for example due to large charitable donations, an estimated itemized deduction may be used instead.

IRMAA

If you predict you'll be in the range of the 1st through 3rd of the IRMAA tiers, add a representative tax rate to your overall marginal tax rate, about 5% as of 2024. If you are confident you'll be in the 4th IRMAA tier or above, or well below the 1st IRMAA tier, do not add any tax rate for IRMAA.

The "spike" behavior of IRMAA makes planning difficult, as actual IRMAA marginal tax rates will be either large (if an IRMAA tier threshold is crossed) or zero. Applying an average tax rate give as much accuracy as is possible for a long-term analysis. For a shorter-term analysis, such as Roth conversions in early retirement, using exact tier thresholds may make sense, although there is still the problem of the two-year delay.

Analysis

Look up the total income minus deductions in today's tax rate table for your expected filing status, including any Social Security phase-in, and adding any expected state tax rate and IRMAA rate, as applicable.

Compare your estimated future marginal tax rate to your marginal rate today, making any adjustments for maxing out accounts, Saver's credit, and/or not getting the full employer match as applicable. If the numbers are close or equal, it likely will not make much difference which you pick, so you might choose to mix traditional and Roth contributions, to take advantage of tax diversification.

If this analysis shows that your planned contribution choices were correct, you can be confident in that result. If not (eg. assuming traditional contributions in the current year and similar future years says Roth is preferred), then rerun with different assumptions. If neither choice appears correct (eg. assuming traditional contributions says Roth is preferred, and assuming Roth contributions says traditional is preferred), the optimal choice is some split; see Straddling brackets.

Results

Most investors will find that traditional contributions are better during their normal working career, for two reasons:

  • Retirees usually need lower income than while working to maintain the same standard of living, because they are no longer saving for retirement, expenses for children have ended, the mortgage is probably paid off, many retirees relocate to lower cost-of-living areas, work-related expenses have ended, life and disability insurance are no longer needed, etc.
  • Retirees pay a lower tax rate on the income they do draw, because lower income usually means lower tax rates, many retirees live in low-tax or tax-free states, Roth withdrawals and return of basis from taxable investments are tax-free, capital gains are taxed at a reduced rate, payroll taxes have ended, Social Security is 15-100% federally tax-free and not taxed by many states, HSA withdrawals for medical expenses are tax-free, etc.

There are plenty of exceptions to this rule, however, including those with very high or very low incomes, planning to move from low-tax to high-tax states, heavy savers who expect more taxable income in retirement than while working, planning to leave money to higher-tax heirs, working around unusual tax laws, and others. A non-exhaustive list of cases where Roth contributions are preferred is above.

If you currently have very little tax-deferred retirement savings, your calculated retirement tax rate will be very low, so you’ll get a big value by contributing more. In fact, due to the federal standard deduction, the first $16,550 or $32,300 you withdraw in retirement each year (assuming you are over age 65 at the time) should be tax-free. (These values decrease slightly, but not much, with significant Social Security income). Assuming a 4% withdrawal rate, that corresponds to an account balance of $413,750 (= $16,550 / 4%) or $807,500 (= $32,300 / 4%) that can be accessed federally tax-free, and these figures should grow with inflation.

As your tax-deferred balance rises, so will your expected tax rate, but as long as it is less than your marginal tax rate now it still makes sense to contribute to tax-deferred accounts. If your expected retirement marginal tax rate ever reaches or exceeds your current marginal tax rate, and you still want to save more, then additional savings should be done in a Roth account.

Example

A single investor earns $220,000 gross income and has a marginal tax rate of 32%. He plans to retire in 25 years at age 65. He currently has $500,000 in traditional (tax-deferred) savings, contributes $23,000 per year to this account, and expects it to grow at 8% after fees, and assumes 3% inflation. He expects to take $3,200 per month inflation-adjusted Social Security benefit immediately after retiring, of which he expects 85% to be taxable. He has a taxable account, but the income from that account stacks on top of traditional withdrawals and should be taxed at 15%, and shouldn't affect taxation of Social Security benefits as that will be at 85% regardless, so it can be ignored for this analysis. He does not expect any other additional income in retirement.

His 401(k) allows either traditional or Roth contributions; which should he be making?

Given his relatively high income compared to his savings, it is reasonable to guess that continuing to make 100% traditional contributions will be best. Assuming he continues to make $23,000 traditional contributions, his predicted retirement marginal tax rate could be calculated as follows:

Taxable Income Source Excel Calculation Value
Traditional Savings Withdrawals =FV(8%-3%,25,-23000,-500000) * 4% $111,636
Taxable Social Security Benefits =3200*12*85% $32,640
Single Standard Deduction (age 65+) N/A -$16,550
Predicted Taxable Income =SUM(above values) $127,726

Under the current tax bracket structure, his future marginal rate with that income is predicted to be only 24%, which is less than his current marginal rate is 32%. The assumptions in this analysis (maximum ongoing traditional contributions, and maximum Social Security taxation) represent a "worst case" for taxable income in retirement.

Because his marginal rate is still predicted to be less than today, the guess was correct, and he should prefer traditional contributions to Roth for the current year. He should repeat this analysis each year, accounting for actual investment growth and tax law changes.

Other tax considerations

State taxes

Consider state taxes as well as federal taxes in your tax rate comparisons, both for the state you live in and for the state you expect to retire in.

Some states do not allow deductions for traditional account contributions, or only allow them for some types of contributions (New Jersey, for example, allows deductions for 401(k) but not 403(b) or IRA contributions); if you live in such a state, the Roth has an advantage.

If your state allows a deduction but you might retire in a state which has no tax or will not tax your traditional IRA withdrawals, then the traditional IRA has a potential advantage.

Conversely, if your state has no income tax but you might retire in a state which taxes traditional IRA withdrawals, the Roth has a potential advantage.

Estate planning

For those planning on leaving a significant estate to their heirs, multi-generational effects should be considered.

For example, if you are a high earner in the 32% tax bracket, and expect to be throughout retirement, but your heirs are lower earners in the 12% tax bracket, you should prefer traditional contributions - your heirs will receive a larger inheritance after tax.

Likewise, if you are in a lower tax bracket than your heirs, you should prefer to contribute to Roth accounts. If you plan to bequeath assets to a tax-exempt charity, that bequest should be from a traditional account as opposed to a Roth, because neither you nor the charity will pay taxes on the funds, and the charity will receive a larger donation.

The SECURE Act of 2019 now requires most non-spouse inherited IRAs to be completely distributed by the end of the tenth calendar year following the year of the owner's death. If you expect to leave large IRAs as part of your estate, such that withdrawals will likely push your heirs into a tax bracket higher than yours is now, favor Roth contributions and conversions during your lifetime.

Furthermore, in 2022 the IRS proposed regulations that would require RMD’s during years 1-9 for some (not all) beneficiaries affected by the 10 year depletion rule. Roth IRAs subject to the 10 year rule do not require RMD’s year 1-9.[6]

See the Stretch IRA page for strategies for large inherited IRAs. For small IRAs that will not affect your heirs' tax status, simply comparing your marginal tax rate to your heirs' current rate will be sufficient.

For those who choose to leave large IRAs to beneficiaries in testamentary or other irrevocable trusts, the tax rates of income recognized within most such trusts are accelerated and the brackets are compressed[7]. For 2024, trust taxable income over $15,200 is taxable at 37% (for income held within the trust, not distributed from the trust). For those that choose to keep the income in trust as long as possible in order to take advantage of trust protections, having a Roth within a trust avoids recognizing future RMDs within the trust at a potentially much higher tax rate.[8]

The federal estate tax exemption, $13.61M for individuals and $27.22M[9] for married couples as of 2024, is calculated without regard to whether the accounts are traditional or Roth. This would suggest that Roth contributions and conversions would be beneficial in lowering your estate tax liability, assuming the owner's and heir's marginal tax rates are the same. However, the IRS allows a deduction for Income in Respect of a Decedent on estate taxes paid when withdrawing from a traditional account[10], and this deduction equalizes the taxes when marginal income tax rates are the same. However, states generally do not allow a similar deduction for state estate taxes[11], so for those likely to pay state estate tax, Roth again has an advantage.

Opportunity to convert later

If you contribute to a traditional IRA, you can convert to a Roth IRA in a later year. If you contribute to a traditional 401(k) and leave your employer, you can roll the 401(k) into a traditional IRA and then convert it later, or roll it directly to a Roth IRA. Your income (and therefore marginal tax rate) might be lower in a year when you separate from an employer. In either case, you may come out ahead if you can convert in a lower tax bracket, because you pay the taxes in the year of conversion instead of the year of contribution. There is no analogous "traditional conversion" whereby you can move money from a Roth account to traditional and reduce your taxable income, so this is an advantage for traditional accounts.

This increases the benefit from using traditional accounts when you retire in a low tax bracket. If you retire in a 12% tax bracket before taking Social Security, and do not need the whole 12% tax bracket for living expenses, you can convert part of your traditional IRA to a Roth at 12%, reducing the amount you will have in the IRA when you start taking Social Security.

But if you expect to retire in the same tax bracket, this is not a significant extra advantage for the traditional accounts. If you are usually in a 22% tax bracket and retire in a 22% tax bracket but happen to have some years in a 12% bracket (large deductions, unemployed part of the year, one spouse takes off from work or works part-time to care for children), you can convert up to the top of the 12% bracket in those years, and you can make those conversions from any traditional accounts you have, whether or not you have Roth accounts.

Required Minimum Distributions

Traditional accounts have the disadvantage of having Required Minimum Distributions (RMDs) begin at age 72. (Roth 401(k)'s have RMD's as well[12], but can easily be rolled over into a Roth IRA upon retirement,[13] and Roth IRA's do not have RMD's). RMD's are a reasonable percentage of the account balance, but if you expect to want to leave large IRAs as part of your estate and RMD's would hinder this goal, then prefer Roth contributions.

Tax risk

If all else is equal (that is, you expect to retire in the same bracket, and never to have the opportunity to convert in a lower bracket), the Roth account has a slight advantage because there is less tax risk. You might not retire with the same marginal tax rate that you expect, either because tax rates change or because your taxable income is higher or lower.

Traditional accounts have a slight advantage when future income is uncertain. Choosing traditional today and being wrong usually means you have more money than you expected in retirement, which is not the worst problem to have. But choosing Roth today and being wrong means you had a significant shortfall in savings for some reason. The size of this asymmetry and whether it should impact decisions today is debated.

Another risk for MFJ filers is the death of one spouse, leaving the survivor with single filing status and its higher marginal rates. Especially if one or both spouses has health issues, it may make sense to bias toward Roth accounts to insure against this possibility.

Tax diversification

Tax Diversification is the principle that having assets spread across different kinds of accounts (traditional, Roth, taxable, etc). The further you are from retirement, the harder it is to predict what tax law will be.

By diversifying between current and future tax rates, you effectively provide yourself insurance against large tax rate changes (up or down). Also, it may be the case that there will be certain steep phase-outs, or "bumps" in marginal rates in the future (eg. the current Social Security taxation bumps). Having the flexibility to control your taxable income to some degree might allow you to better optimize around future tax laws.

Conversely, if you only have traditional investments, you will be required to withdraw RMD's or whatever you need to live on, and pay whatever tax results. Even if the traditional vs. Roth analysis described above favors one type or the other, there is a potential advantage to having a mix.

Investment options

You may have different investment options in traditional and Roth accounts. If your employer offers a traditional 401(k) but not a Roth 401(k), then you must use traditional accounts if you invest in the 401(k). If you are over the income limit for a deductible traditional IRA, then you must use a Roth account if you invest in an IRA (a non-deductible IRA cannot be better than either a deductible or Roth account). The choice of account, or benefits within the account, may be more important than the different tax treatment of traditional and Roth accounts.

Employer match

If your employer matches 401(k) contributions, this is by far the best investment you can make, as it has an immediate return equal to the match rate. Therefore, regardless of the quality of your employer's plan, you should get the maximum match before investing anywhere else.

If your employer offers both traditional and Roth accounts, any match goes to a traditional account, and the match is calculated without regard to whether your contribution is traditional or Roth. Therefore, if you cannot contribute enough to a Roth account to get the maximum match, you can get a larger match for the same out-of-pocket cost by choosing traditional contributions. You should choose traditional contributions when:

(derived here)

where:

Note that if , then the equation simplifies to a simple comparison of current and future marginal rates.

Example

You can afford to contribute $3,000 out-of-pocket (after taxes) to an employer 401k, with both traditional and Roth options, that matches 100% of the first $4,000 of contributions. Your current marginal tax rate is 12%, and your expected marginal tax rate at withdrawal is 18.5% due to taxation of Social Security benefits. You can contribute $3,000 to the Roth account and receive a $3,000 traditional match, or $3,409 (=$3,000 / (1 - 12%)) to the traditional account, and receive a $3,409 traditional match. The break-even marginal tax rate at withdrawal is calculated as:

Because the predicted marginal tax rate at withdrawal (18.5%) is less than this value, traditional contributions are preferred. If the match rate were only 50%, or if the marginal tax rate at withdrawal were 22%, then Roth would be preferred instead.

Investment quality and fees

Many 401(k) plans, and even more retirement plans of other types such as 403(b) plans, have inferior investment options.

If you invest in high-cost funds in a 401(k), you will usually lose more to the high costs than you can gain from any tax difference between the 401(k) and IRA.

Some plans have only high-cost options; in such a plan it is better to max out your IRA (traditional or Roth) before making unmatched contributions to the 401(k).

Other plans have some low-cost options, but have no options or high-cost options in some asset classes. In such a plan, you should prefer to invest enough in an IRA (traditional or Roth) to cover the asset classes with no good option in the 401(k).

Once your IRA is maxed out, it is usually worth contributing even to a bad 401(k). Conversely, some retirement plans, such as the Thrift Savings Plan, have better options than are available to retail investors in IRAs. If you have such a plan, you may prefer that plan to an IRA, even at a tax cost.

Investment quality and tax considerations can be combined into the same calculation, by using the Growth_factor in addition to the marginal tax rates. See also: Comparison between IRAs and employer accounts.

Example

You can either contribute $5,000 pre-tax earnings to a traditional 401(k) or a Roth IRA. Your marginal tax rate is 22% now, predicted to be 12% in retirement. The investment is expected to grow at 8% before fees in either case, but the traditional 401(k) charges a 1.00% expense ratio, and the Roth IRA charges a 0.04% expense ratio. Either investment would be withdrawn in 20 years. The future after-tax values of the two investments will be as follows:

Traditional 401(k): $5,000 * (1 + 8% - 1%)^20 * (1 - 12%) = $17,026.61
Roth IRA: $5,000 * (1 + 8% - 0.04%)^20 * (1 - 22%) = $18,043.56.

Assuming the investments are held for the full 20 year term, the fees in the 401(k) outweigh the tax savings, and the Roth IRA is a superior investment.

However, the tax savings from the traditional contribution is immediate, whereas the fees reduce performance gradually over time. In this circumstance, if you expected to separate from your employer well before the 20 year term, you could roll the 401(k) into either a low-expense traditional IRA, or the 401(k) at your new employer.

Depending on how long the money remained in the high-expense 401(k), you might come out ahead contributing to the 401(k) now.

Complex cases

Social Security benefits

One important exception is the phase-in of taxation of Social Security benefits. If you are in the phase-in range, you may experience a marginal rate in retirement of 22.2% or 40.7% despite being in the 12% or 22% brackets.

The 22.2% "bump" affects Social Security recipients with annual Social Security benefits less than $25,922 (Single) or $66,413 (Married Filing Jointly), and the 40.7% bump affects those receiving more than these values. See the main article for more details on where these formulas come from, and for useful visualizations of the phase-in effects.

As a function of annual Social Security benefit (SS), the 22.2% bump begins and ends at the following levels of income from other sources:

Filing Status 22.2% Bump Begins 22.2% Bump Ends
Single $34,000 - 0.5 * SS $28,706 + 0.5 * SS
Married Joint $46,9773 - 0.2297 * SS $36,941 + 0.5 * SS

As a function of annual Social Security benefit (SS), the 40.7% bump begins and ends at the following levels of income from other sources:

Filing Status 40.7% Bump Begins 40.7% Bump Ends
Single $47,622 - 0.2297 * SS $28,706 + 0.5 * SS
Married Joint $85,405 - 0.2297 * SS $36,941 + 0.5 * SS

The 40.7% bump is more abrupt, because it is bracketed by 22.2% below and 22% above. The 22.2% bump is bracketed by 18% below and 12% above. If you are reasonably close (10-15 years or less) to retirement and are in the benefits and income range where you may be affected by either bump, you should try to either come in under the bump, or go far above it, depending on which option is easier.

For those making traditional contributions, switching to Roth to lower taxable income in retirement might be the easiest option.

Example

A single investor, age 55, earns $80,000 gross income and has a marginal tax rate of 22%. He plans to retire in 10 years. He currently has $750,000 in traditional (tax-deferred) savings, expected to grow at 6% after fees, and has been making $12,500 annual contributions. He has no significant taxable investments. He expects to receive a $3,000 per month inflation-adjusted Social Security benefit starting upon retirement at age 65. He does not expect any additional income in retirement, from part-time work, investments income, rental properties, pensions, etc.

His 401(k) allows either traditional or Roth contributions; which should he be making? Making the overly-simplistic assumption that 50% of his Social Security benefit is taxable, his predicted retirement marginal tax rate could be calculated as follows:

Taxable Income Source Excel Calculation Value
Traditional Savings Withdrawals =FV(6%-3%,10,-12500,-750000) * 4% $46,049
Taxable Social Security Benefits =3000*12*50% $18,000
Single Standard Deduction (age 65+) N/A -$16,550
Predicted Taxable Income =SUM(above values) $47,499

By inspection of the tax bracket structure, his future marginal rate would be 12%, less than today, so it would seem that traditional contributions would be preferred.

However, the picture changes when considering Social Security taxation. Because he receives more than $25,922 annual benefit, he is susceptible to the 40.7% bump. Using the above formulas, the bump begins and ends at the following levels of other income:

40.7% Bump Calculation Value
Begins $47,622 - 0.2297 * $36,000 $39,351
Ends $28,706 + 0.5 * $36,000 $46,706

Unfortunately, his $46,049 traditional withdrawals put him near the top of the 40.7% bump. If he instead contributes $9,750 per year to his 401(k) as Roth for the next 10 years, his future income from traditional accounts will be reduced to $40,317 (=FV(6%-3%,10,0,-750000)*4%). This is still in the bottom of the 40.7% bracket, but avoids realizing having about $6,000 of income taxed at 40.7%. Roth contributions are by far the better choice.

Straddling brackets

Note that the marginal tax rates now and in the future can be affected by the amount contributed to traditional accounts. For example, contributing the full $23,000 to a traditional 401(k) might bring an investor down from the 32% bracket into the 24% bracket. Likewise, contributing more to traditional accounts might raise the predicted future marginal tax rate such that it might cross into a higher bracket.

In these cases, the traditional vs. Roth analysis should be done for each dollar invested; contributions can be divided in any proportion. The higher the investment performance, longer the time horizon, and higher the contribution limit to traditional accounts, the more likely straddling becomes.

Example

A married couple earns $480,000 gross income and plans to retire in 30 years. They currently have $400,000 in traditional (tax-deferred) savings, expected to grow at 9% after fees. They can contribute up to $92,000 total to their 401(k) accounts, $46,000 of which can be traditional only, and the remaining $46,000 can be either traditional or Roth. They can afford to contribute $92,000 if all contributions are traditional, or the equivalent lesser amount if some are Roth.

They also have a taxable account, but income from that account stacks on top of traditional withdrawals, and is expected to all be taxed at 18.8%, so it can be ignored. They expect to each receive a $40,000 per year inflation-adjusted Social Security benefit, of which 85% will be taxable. They do not expect any additional income in retirement, from part-time work, investments income other than tax drag from the taxable account, rental properties, pensions, etc.

Should they make traditional or Roth 401(k) contributions with their $46,000 per year? For fully traditional contributions, their predicted retirement marginal tax rate could be calculated as follows:

Taxable Income Source Excel Calculation Value
Traditional Savings Withdrawals =FV(9%-3%,30,-92,000,-400000) * 4% $382,830
Taxable Social Security Benefits =40000*2*85% $68,000
Married Standard Deduction (age 65+) N/A -$32,300
Predicted Taxable Income =SUM(above values) $418,530

Assuming the current tax system remains in effect, their future marginal rate is predicted to be 32%. Their current marginal tax rate with full traditional contributions would be 24% (taxable income = $480,000 - $92,000 - $29,200 = $358,800). On these assumptions, it appears as though they should prefer Roth contributions.

However, if the calculation is run assuming maximum Roth contributions, the result is different:

Taxable Income Source Excel Calculation Value
Traditional Savings Withdrawals =FV(9%-3%,30,-46000,-400000) * 4% $237,363
Taxable Social Security Benefits =40000*2*85% $68,000
Married Standard Deduction (age 65+) N/A -$32,300
Predicted Taxable Income =SUM(above values) $273,063

Their future marginal rate would therefore be only 24%, and their current marginal rate with full Roth contributions would be 32% (taxable income = $480,000 - $46,000 - $29,200 = $404,800), the opposite of before. The optimal solution is to split contributions between traditional and Roth contributions.

For simplicity, we can check six possible proportions for the elective portion of the contribution, although in practice, spreadsheet or optimization software could automate this calculation to be more precise:

Traditional Contribution Roth Contribution Taxable Income Now Taxable Income Future Marginal Rate Now Marginal Rate Future Result
$0 $33,288 $404,800 $273,063 32% 24% Too much Roth
$9,200 $27,032 $395,600 $302,156 32% 24% Too much Roth
$18,400 $20,776 $386,400 $331,250 32% 24% Too much Roth
$27,600 $13,984 $377,200 $360,343 24% 24% Close to optimal
$36,800 $6,992 $368,000 $389,437 24% 32% Too much traditional
$46,000 $0 $358,800 $418,530 24% 32% Too much traditional

By splitting the contribution, this couple can lower their total taxes by staying within the 24% bracket both now and in retirement. Note that this analysis is extremely imprecise; it depends on future contributions being made, investments performing as expected, and the tax code remaining the same, most of which are very unlikely to occur.

However, current tax rates are well-known, so if the optimum traditional contribution is close to a step down in marginal rate, it is usually a good idea to contribute just up to that step, then contribute the rest to Roth. In this case, a traditional contribution of $20,900 is probably best, as it puts the couple's taxable income exactly at the 24%/32% bracket boundary at $383,900.

They would therefore also contribute $19,076 (=[$46,000 - $20,900] x [1 - 24%]) to Roth.

Maxing out your retirement accounts

The IRS sets a maximum contribution to retirement accounts. If you have reached this maximum, anything else you contribute must be in a taxable account that will (if you pay more than 0% on annual earnings or capital gains) lose money to taxes not incurred in either a traditional or Roth account.

The IRS contribution limits do not distinguish between traditional (pre-tax) and Roth (after-tax) accounts. Because after-tax money is worth more than pre-tax money, Roth accounts effectively allow you to contribute more than traditional accounts.

For example, if your marginal tax rate is 32%, a $23,000 Roth 401(k) contribution will tax-shelter $33,824 (=$23,000 / (1 - 32%)) of pre-tax earnings, whereas a traditional 401(k) contribution can only tax-shelter $23,000.

A fair comparison between Roth and traditional contributions when at a fixed-dollar limit must therefore also take into account the performance of the remaining money in a taxable account.

The after-tax amount invested in the taxable account is simply the tax savings from the traditional contribution, in this case $7,360 (=$23,000 * 32%).

The future after-tax values of the traditional account plus the taxable account can then be compared to the Roth account.

The equivalent conversion decision would be to convert a $23,000 traditional IRA to a Roth IRA, paying the $7,360 tax with money that would otherwise have been invested in a taxable account.

When contributing the maximum, traditional contributions have a higher after-tax value when:

with

and

Variables are defined as:

The formula is derived here. That page also contains a more complex formula that includes different rates of return for different accounts.

Other factors affect this decision besides simply after-tax value. The combination of traditional and taxable money retains more flexibility than the Roth; traditional money can be converted to Roth in future years, and taxable money can be withdrawn at any time penalty-free. On the other hand, effectively sheltering more money inside retirement plans by choosing Roth can have asset protection benefits, and Roth accounts do not require RMDs.

Typical values

The following table calculates the break-even withdrawal tax rates for various sets of tax rates at different time horizons. All cases assume an investment with a total return of 8% and yield of 2%, of which 90% is taxed at long-term capital gains rates and 10% as ordinary income. If your withdrawal rate is predicted to be above the result in the table, Roth is preferred.

Tax rates Time (years)
Ordinary income Long-term capital gains 10 20 30 40
12.0% 0.0% 11.97% 11.95% 11.92% 11.89%
24.0% 15.0% 21.87% 20.58% 19.67% 18.96%
32.0% 18.8% 28.43% 26.27% 24.78% 23.62%
37.0% 23.8% 31.83% 28.75% 26.68% 25.11%
50.3% 37.1% 39.56% 33.45% 29.57% 26.79%

Note how dramatic the effect is for investors with high tax rates; even with a marginal tax rate today of 50.3%, after 40 years Roth contributions give more money after taxes with a withdrawal rate above just ~27%.

Very high income and wealth

Investors with high income and wealth, who expect to be in the top tax bracket now and in retirement, should usually prefer Roth contributions, for these reasons:

  • Being in the same (top) tax bracket now and in retirement eliminates any tax rate arbitrage between contribution and withdrawal, which is a typical advantage of traditional accounts
  • High tax rates on dividends and capital gains heavily degrade the performance of taxable investments, and shift the advantage more toward Roth accounts
  • The asset protection benefits of sheltering more money in Roth accounts are probably more significant for those with high income and wealth, and the higher liquidity of taxable accounts is probably less significant

Example

You are deciding between traditional and Roth contributions in your 401(k), with a contribution limit of $23,000. Your marginal rate now is 24%, your marginal rate in retirement is predicted to be 22%, your tax rate on qualified dividends and long-term capital gains are both 15%.

Your investments in any account are expected to have annual capital growth of 6% and a yield of 2%, for 8% total return, compounding annually. The yield is comprised of 90% qualified dividends and long-term capital gains distributions; the remaining 10% yield is taxed as ordinary income.

You plan to withdraw the money in 25 years. Are traditional or Roth contributions preferred?

The dividend tax rate on the taxable investment is:

The growth factors for the balance and basis of the taxable investment are:


The withdrawal rate below which traditional contributions are preferred is:

Despite the predicted withdrawal tax rate (22%) being less than the current tax rate, Roth contributions have a higher after-tax value. The spreadsheet linked above gives a similar value for a dividend tax rate of 15%. Refer to Figure 1.

Maximizing Contribution Comparison
Figure 1. Maximizing Contribution Comparison

You should decide whether the tax savings (about 2% of the contribution) is worth the partial loss of liquidity.

Saver's credit

Saver's Credit[14] is effectively a match from the IRS on your retirement contributions if you have a relatively low income. The credit is given for contributions to either traditional or Roth accounts. However, there are two advantages which may make traditional contributions more attractive.

If you cannot afford to contribute $2,000 to a Roth account, then you can contribute more to a traditional account for the same out-of-pocket cost to get a larger match. In addition, the credit is based on your adjusted gross income. Contributions to a traditional IRA or 401(k) reduce your adjusted gross income and may make you eligible for the credit, or for a larger credit.

While qualifying for the Saver's credit, traditional or Roth can be decided upon using the following analysis. Traditional contributions are preferred when:

(derived here)

where:

Example

Consider a single filer with $30,000 gross income. For that person, up to a $2,000 contribution, and .

For a $2,000 traditional contribution, the equivalent Roth contribution is .

The withdrawal marginal tax rate for equivalent results is:

.

If this investor expects the actual withdrawal marginal tax rate will be less than 13.3%, traditional is better. If more than 13.3%, Roth is better.

Real-world example

The methods described earlier in this article assume that your marginal tax rate vs. contribution curve is either flat or decreasing, and your marginal tax rate vs. withdrawal curve is flat or increasing. This behavior would be typical of a simple progressive tax system.

The US tax code, however, is not simple. Some credits, e.g., the Earned Income Tax Credit (EITC) and the Saver's credit, may apply only after a certain amount of low benefit contributions. Similarly, the Taxation of Social Security benefits may cause high rates on some portion of withdrawals, but past that portion the rates decrease.

The following example illustrates the general method for dealing with real-world non-progressive tax curves, but is based on older tax brackets, so the numbers should not be taken as correct for the current tax year. Consider a couple with two children earning $54,000 per year gross income. Their marginal tax rate curve is shown in Figure 2.

Tax Rate vs. 401k Contribution
Figure 2. Tax Rate vs. 401k Contribution (negative values because tax decreases as contributions go up)

The plot has negative values because the tax goes down as the 401(k) contribution goes up. The rest of this example follows the convention of ignoring the negative sign and refers to the rate at which tax was avoided when using "tax rate."

Their marginal tax rate goes through regions of 22%, 43%, 33%, 31%, and 21%, and there is a $200 spike due to a change in the saver's credit tier from 10% to 20%.

  • 22%: 12% bracket plus 10% saver's credit
  • 43%: 12% bracket plus 10% saver's credit plus 21% Earned Income Tax Credit phase-in
  • 33%: 12% bracket plus 21% Earned Income Tax Credit phase-in (saver's credit maximum contribution reached for this example)
  • 31%: 10% bracket plus 21% Earned Income Tax Credit phase-in
  • 21%: 0% bracket plus 21% Earned Income Tax Credit phase-in

Method

In order to capture the effect of the various peaks, valleys, and spikes, remember the operative definition of marginal tax rate: [total additional tax] / [total additional contribution]. In the chart above, the "Cumulative" curve shows that calculation for the given starting point.

For example, even though the marginal tax rate is 43% for contributions between $1,500 and $2,000, this couple would have to contribute $1,500 at only 22% in order to achieve that benefit. A $2,000 401(k) contribution would result in a tax decrease of $543.83, for a marginal tax rate of about 27% ($543.83 / $2,000). If the marginal tax rate on withdrawals is fixed, a simple method to optimize contributions is as follows:

  1. Starting at a traditional contribution of $0, calculate the marginal tax rates ([total additional tax saved] / [total additional contribution]) for all contributions between the starting point and the maximum contribution (limited by either IRS rules, or how much you can afford to save).
  2. Find the maximum marginal rate and the corresponding contribution
  3. If the maximum marginal rate is greater than your predicted marginal tax rate at withdrawals, make that traditional contribution. Then return to Step #1 with the starting $0 reset to the traditional contributions so far. If the contribution marginal tax rate becomes lower than the expected withdrawal tax rate, contribute remaining retirement savings to Roth accounts.

It may be helpful to use charts such as the example given here to understand these situations. You can download the Personal finance toolbox Excel spreadsheet and use it for a wide variety of tax situations. Simply eyeballing the chart, it appears that somewhere between $13K and $14K would be the best traditional contribution. See below for more exact numbers.

Analysis

The married one-earner couple described above predict a 22% marginal tax rate in retirement. They can afford to save $10,000 after taxes to retirement accounts. How much should they contribute to traditional and Roth accounts?

  • Starting from $0 contribution, their maximum marginal savings rate is at a 401k contribution of $12,500, just enough to reach the 20% Saver's credit tier. This contribution results in a total tax savings of $4,169, for an incremental savings rate of ~33.35%. This rate is higher than the expected marginal tax rate on withdrawals of 22%, and the after-tax cost of $8,331 ($12,500 - $4,169) is less than the maximum, so contribute $12,500 to traditional accounts and try another iteration.
  • Starting from $12,500 contribution, their maximum incremental savings rate is at an incremental contribution of $1,100, resulting in an incremental tax savings of $342, for an incremental savings rate of ~31.1% ($342 / $1,100). This rate is still higher than the withdrawal tax rate, and the total after-tax cost is $9,089 ($1,100 - $342 + $8,331), so contribute an additional $1,100 to traditional accounts and try another iteration.
  • The marginal rate for all traditional contributions beyond $13,600, up to the $19,000 IRS limit, is ~21.06%. This is less than the marginal tax rate on withdrawals, so contribute no additional traditional money. Contribute the remaining $911 ($10,000 - $9,089) to Roth accounts. To maximize the saver's credit, the $911 should be contributed by the non-earning spouse. If both spouses are eligible for a 401k, having each contribute at least $2,000 will maximize the saver's credit, and then who contributes to the Roth does not matter.

These steps can be summarized in the following table:

Cumulative traditional contribution Incremental traditional contribution Incremental tax savings Incremental savings rate Cumulative after-tax cost Invest?
$12,500 $12,500 $4,169.15 33.3532% $8,330.85 Yes
$13,600 $1,100 $341.66 31.0602% $9,089.19 Yes
Up to $19,000 Up to $5,400 Up to $1,137.25 21.0602% Up to $13,351.93 No

The optimal retirement contributions for this couple are $13,600 to traditional accounts and $911 to Roth.

Additional examples may be found in Traditional versus Roth examples.

Direct calculation method

For situations where both the marginal savings rate and marginal tax rate at withdrawal are irregularly shaped (perhaps due to taxation of Social Security benefits), direct calculation of future after-tax value in retirement is best. One possible method could be as follows:

  1. For every possible traditional contribution, calculate the maximum amount of Roth and taxable contributions that can be made while still having enough spending money to cover expenses.
  2. For each case, calculate the future value (using "=FV" in Excel, or similar) of the traditional, Roth, and taxable accounts at retirement.
  3. Calculate the total taxes due in retirement, and the after-tax value of investment withdrawals. The set of contributions with the highest after-tax value is best.
  4. The analysis should be repeated every year.

See also

  • Traditional versus Roth examples contains additional examples, covers some real but unusual situations, and in general provides more details for those seeking them.

Notes

  1. Different results occur if you compare a Roth contribution against the same traditional contribution and ignores the tax cost (and thus lower spendable income) in the contribution year. This may be considered a form of enforced savings and simply by virtue of “saving more” will favor Roth but is not the same thing as the apples-to-apples comparison discussed in this article.

References

  1. IRS Publication 590-B: Distributions from IRAs
  2. IRS Roth Comparison Chart
  3. Roth 401(k) vs. 401(k) Spreadsheet Attempt
  4. Why Roth conversions always pay off—if you can hold on long enough
  5. How do RMDs affect Roth conversion choices?
  6. Christine Benz (March 20, 2024). "Be Aware of These New Rules for Inherited IRAs". Morningstar.
  7. IRS (2024). "2024 Form 1041-ES" (PDF). p. 5.
  8. Natalie Choate (April 20, 2022). "Using Retirement Accounts to Provide for a Disabled Child". Morningstar.
  9. Small Businesses and Self-Employed: Estate Taxes, IRS.
  10. "Understanding the IRD Deduction That Inherited IRA Beneficiaries Often Miss". Kitces Nerd's Eye View. Retrieved May 21, 2023.
  11. Bogleheads forum post: "Re: Proposed update to the Roth Conversion wiki page", bsteiner. May 20, 2023
  12. IRS list of accounts subject to RMDs
  13. IRS rollover chart
  14. Get Credit for Your Retirement Savings Contributions, and IRS Form 8880: Credit for Qualified Retirement Savings Contributions

Further reading

External links

Bogleheads forum discussions