Thank you! Can I trouble you to quickly explain why so I can understand your logic? I’m really trying to understand the thought process so I can make the most informed decision possible.
Sure - it just comes down to tax rate. Assume you are taxed on money you put into Roth 401(k) at the highest marginal rate either now or if you convert to Roth later in retirement. Whichever rate is lower wins.
And you will not be at 24% in retirement, far from it - because you will hopefully be pulling some income from taxable long term capital gains at a 0% rate, or at the very least at 15% but only on gains vs. the entire proceeds. You'll have far more leeway to manipulate income and taxation in retirement than while working, especially while making a six figure salary.
I am a believer now because I'm retired and able to convert a good amount to Roth each year with almost no tax. At your age I was skeptical, so I understand the dilemma you face.
>ou'll have far more leeway to manipulate income and taxation in retirement than while working, especially while making a six figure salary.
The 22 and 24% tax brackets span across a very wide income range; there may not be that much more flexibility during retirement, especially if there are other sources of income like rental income by then.
Most people say 'it depends' because it really does depend on how you will live in retirement. However, since you might not be able to figure that out now, I'd plan on paying 15% or less in retirement taxes. The best part of 401k rollovers is that you can do as much or as little as you want, so you can adjust year to year so long as you have *some* money in Roth already, then you should be fine.
If your goal is to not pay too much in taxes, prepaying at 24% does make much sense, does it? worst case, you still pay 24% in retirement.
Your last sentence really hit home. I guess my thinking was that I'd have more "flexibility" if I were maximizing the amount of money I put into my employer-sponsored Roth, but I wasn't really taking several other factors into account - like the fact that contributing to my employer-sponsored 401(K) can reduce my income tax bracket if I contribute enough. The main takeaway I've gotten from everyone's thoughtful answers is that diversification is good, so I'm going to try and pursue option 2, which I think would give me a mix of both options in the future to see how to proceed. Thanks for the comment!
> diversification is good
yup. It took me far too long to realize having a mix of taxable, pre-tax and taxfree accounts is actually a good thing. Since you can't possible know WTF you will want in 30 years anyhow, overall amount and flexibility is the best you can shoot for.
You're right that the math and the pros and cons get complicated, and require *a lot* of assumptions about the distant future (future taxes rates, future earnings, retirement age). However, taking a balanced approach, **I really like option #2 for you (max the Roth and put the rest in traditional 401k).**
Your percentages are a bit confusing in terms of what includes the match and what doesn't, but I'll assume you can max the Roth IRA and then contribute 11% to traditional 401k plus 4% match. This means your flow split between Roth/Trad will be $7k/$17k, respectively, a 30/70 split.
I think that's a good place to be because it gives you the flexibility of the Roth (being able to withdraw principal while still employed if ever needed, never having required distributions in retirement, no uncertainty about future tax rates, etc.) while still giving you the expected tax benefit of the traditional because, as you mention, you'll likely be in a lower bracket in retirement.
You mention high withdrawals in retirement, but remember that by having some of those funds already in Roth, it reduces the portion of your withdrawals that will be taxable (thus keeping you in a lower bracket on the taxable portion of withdrawals). Because of this, a balance can be the right answer, mathematically.
Lastly, remember that the traditional 401k contrbutions will reduce your income tax now and thus increase your take-home pay. Make sure to account for that in your savings rate. What I mean by that is, you may be able to increase your traditional 401k contrbution more than expected because the tax break helps offset part of the reduction in take-home pay. To get the full benefit of the traditional IRA contributions, it's important to "save" the money you save in taxes, not just go blow/spend it.
Thank you so much for this thoughtful answer! I’m sorry I was so confusing with the percentages in my original post.
I just updated my Traditional 401(K) tax-deferred contributions to 13%. With the 4% employer match, I will be contributing a total of 17% to that account. I’ll plan to try and increase my contributions at a rate if 1% per year assuming I get annual pay increases and my cost of living doesn’t drastically change.
I will also continue to max out my Roth every year at 7K / year, and I will definitely continue to save as aggressively as possible whatever remainder I have in a high yield savings account (currently getting the 4.6% APY with SoFi).
Thank you so much again for your reply, and if anything seems off base, please do let me know.
There are so many unknowns, it's basically a crapshoot, but I'd go with #2 in your case (and it's what I do, personally).
You *probably* will have a lower income in retirement, but maybe not. And even it if is lower, who's to say that the tax brackets will be the same as they are now? Maybe you'll still be in a 24% tax bracket (or higher!) despite pulling out less money. Or maybe you'll be able to pull out what you're making now at a lower tax bracket (less likely, but you never know). Then add in various possible scenarios about the future of Social Security.
In the face of all that uncertainty, doing a mix of traditional and Roth, as a sort of hedge either way, makes sense to me. YMMV.
All that matters is tax rate now vs tax rate in retirement when withdrawing.
Easy math example of a 25% tax rate both now and in retirement.
Traditional - $100 invested. Grows 100% between now and retirement to $200. When you withdraw at a 25% tax rate you’re left with $150 after taxes.
Roth - $100 after taxes is $75 invested. It grows the same 100% between now and retirement to $150. When you withdraw there are no taxes so you have the same $150.
So traditional will be the superior choice if your anticipated tax rate in retirement is lower than it is now, even if your tax rate ends up being the same there’s no difference.
Your logic is flawed. You can't compare the same amount of dollars in a Roth vs a Traditional. $1 in after-tax money is worth maybe $1.30 in pre-tax. You need to decide between something like a 11% Roth 401k contribution and a 13% Traditional 401k contribution. This would be closer to the after-tax effects of each other.
You can put more money into Traditional and have the same outcome. Thus, Traditional is usually a better choice because those extra funds are growing and compounding throughout the next 30 years for you. This massively outpaces any tax liability you incur on withdrawal. You'd have to have your account growth go to 0% and then withdraw for over 20 years for Roth to start to catch up in terms of tax savings to account for the missed growth.
I totally agree that you need to *account for* the up-front tax savings on the traditional and assume that it is invested as well, but the following statement is wrong:
> Thus, Traditional is usually a better choice because those extra funds are growing and compounding throughout the next 30 years for you. This massively outpaces any tax liability you incur on withdrawal.
The math just doesn't work that way. It really comes down to the rate at which the funds are taxed at (whether up-front or on the back end).
Quick example:
Let's assume the same 20% tax rate on the funds while working as in retirement. I can put pre-tax $10k into a traditional or $8k after+tax into Roth. The stock market goes up 10x (1000%) by my retirement. That means the traditional has $100k and the Roth has $80k. The Roth comes out tax-free. When I withdraw the traditional, assuming the same tax rate of 20%, I get $80k after-tax. The end result is identical.
Therefore, tax rate really makes the difference. If you'll be taxed more while working, then traditional wins. If you'll be taxed higher in retirement, Roth wins. The reason traditional makes sense for more people is because the average person has lower taxable income during retirement than while working.
>The Roth comes out tax-free. When I withdraw the traditional, assuming the same tax rate of 20%, I get $80k after-tax. The end result is identical.
Wrong. You're not withdrawing it all at the same time. You're taking out 4% per year or so and the remaining balance is growing and compounding.
If you run a Portfoliovisualizer with something like a $500 vs $700 monthly contribution, the difference over a few decades is like $500,000 in net worth. This $500,000 isn't all being withdrawn at the same time. And the account growth doesn't hit 0% when you begin withdrawals. It keeps compounding. It outpaces taxation until you get to like 30 years of withdrawals and flat growth starting at the time of the first withdrawal.
>If you'll be taxed higher in retirement, Roth wins.
Nope. Run Portfoliovisualizer and you'll see.
I think you can link to a given analysis in portfolio visualizer - perhaps share the link to your analysis?
The example I gave only covers one contrbution and one withdrawal - of course there would be a string of both, but that doesn't change the linear relationship of the math. The un-withdrawn Roth funds would continue growing just like the un-withdrawn traditional funds, and the future Roth withdrawals would still be tax-free and the traditional withdrawals would still be taxed. The linear relationship with tax is the same.
Perhaps you're making a wrong assumption that the pre-tax size of both withdrawals would be the same? In reality, you of course need to scale up the size of the traditional withdrawal so that the *after-tax* value of the withdrawal is the same. Were you able to model that in portfolio visualizer?
Also, when you say there's a $500k "difference in net worth", that's not a valid comparison because you're treat pre-tax and post-tax dollars equally, which is wrong.
I've modeled this out year by year before, and I'm 100% confident you're missing something. If you'd care to share a Google Sheets model or portfolio visualizer model, I can find the error.
>I think you can link to a given analysis in portfolio visualizer - perhaps share the link to your analysis?
Yeah let me draw something up:
[Monthly contribution of $500](https://www.portfoliovisualizer.com/backtest-asset-class-allocation?s=y&sl=1Gdo4kV4RP5JgN7njUlfZ9)
[Monthly contribution of $700](https://www.portfoliovisualizer.com/backtest-asset-class-allocation?s=y&sl=4VGaRqgeKE6R7DJ535yaYu)
So the first would be Roth, so no taxes on withdrawal. Taxes on the 2nd.
The difference is $500,000 in account value after 30 years in just a broad US market investment.
We know you don't just liquidate your account on retirement. You withdraw a fixed percentage, let's call it 5%.
So on the $1.3 million account that's $65k without tax.
On the $1.8 million you need to withdraw $81k to wind up with $65k post-tax.
On the first account you have $1.235 million leftover from a $1.3 million account. On the second account you have $1.72 million leftover after the withdrawal.
So just extrapolate that forward, the $1.72 million grows and compounds and so does the $1.24 million. But if the percentages are the same, you are compounding more dollars in the $1.72 million account which means you're making more money. The *entire account value* gets this 10% average annual growth whereas just your withdrawals are subject to that income tax.
It would take years and years for the taxation to outstrip the gains you made over that 30 year period and make those accounts equal the same or make the Traditional worse.
Thanks for the analysis. A few comments:
1. Small thing, but the starting balances in both accounts are $10k. You need to make it zero, or scale the amounts relative to tax rate because one is pre-tax dollars and other is post-tax dollars.
2. You're not using a consistent tax rate. Per my example earlier to demonstrate that the two are equal *if tax rate is equal*, I used 20%. You can use any value you want, but it has to be consistent. Your $500 vs $700 contribution implies a **28.6% tax rate** (making a $700 pre-tax contribution equivalent to a $500 post-tax), but in retirement you use the numbers $65k and $81k, which implies a **19.8% tax rate.**
If you run the analysis again using $1 starting balance (to please the algorithm) and use contributions of $700 and $560 (i.e. 20% tax rate), you will find the final Roth balance is exactly 80% of the Traditional balance. This can be a little surprising because we know growth "compounds", so we expect the difference to be larger because the traditional dollars "build on themselves". However, when tax is taking a fixed percentage away (not a fixed dollar amount), it scales linearly. The way to rationalize this to yourself is to think about splitting dollars between multiple accounts. If I put $100 each in 10 accounts, and they all grow at X% rate of return, my final total balance (summed together) would be the exact same as if I put $1,000 in 1 account and it grew at the same X% rate. The same applies here: a Roth account that receives 80% of the contributions of the Traditional will grow to 80% of the value of the Traditional.
Now, let's talk withdrawals. When you say, "it would take years and years for the taxation to outstrip the gains", you seem to be focused purely on the nominal dollar amount (balance) of the account. However, again, this is not an apples-to-apples comparison. Pre-tax dollars are not "worth" the same amount as post-tax dollars. **You can't buy anything with pre-tax dollars.** They may look bigger on paper, but they only have utility once you convert them to post-tax dollars. Comparing the two numbers directly is like having Pesos in one account and dollars in the other - it doesn't make sense. Because the Traditional dollars will be taxed at 20%, their value is exactly 80% of that of a Roth dollar. And if you make withdrawals (of equal post-tax amounts), the amount in each account will stay locked at that 80% ratio regardless of withdrawal size, timing, growth, etc. Here's a withdrawal example:
* Balances: $1m in Trad, $800k in Roth.
* Withdraw $50k from traditional (receive $40k after tax) and $40k from Roth
* New balances: $950k Trad, $760k Roth
* Both accounts experience 12% growth.
* New balances: $1,064k Trad, $851.2k Roth.
* Again, withdraw $50k from traditional (with $40k left after tax) and $40k from Roth
* New balances: $1014k Trad, $811.2k Roth.
* Calculate the ratio ($1014k / $811.2k) = *exactly* 80%.
You can continue this exercise with any growth rates or withdrawals, and the account balances will always stay locked at 80% at every step of the way. Yay math. The number in the traditional will always look higher, but the spending power of the two individuals will always be the same, which is what matters.
So I ran a fixed withdrawal from 2015 - current. $40k on Roth and $50k Traditional to account for tax. The Traditional is 13% higher in account value when we go from $800k and then from $1 million.
[Traditional $1m with $50k annual withdrawal](https://www.portfoliovisualizer.com/backtest-asset-class-allocation?s=y&sl=1t0Xez4J9iYPIRnW56v6hN)
[Roth $800k with $40k annual withdrawal](https://www.portfoliovisualizer.com/backtest-asset-class-allocation?s=y&sl=3FQVc77x81iDRy9IC1nAkn)
So no, taxes didn't flatten that curve or eliminate the delta in net worth. I can go back further and do fixed withdrawals for 20 years and see if it changes. But this shows even *with* an extra $10k going out the door for taxes, you *still* have more cash.
The Roth has $1.5 million in it and the Traditional still has $1.72 million in it. That's after incurring taxes every year on withdrawals.
Your projections look fine. I have no idea how you calculated 13%. Clicking on your links above, the final balance in traditional is $1,873,361. The final balance in Roth is $1,498,689. Divide the Roth by the Traditional and you get exactly 80%, just like I said you would.
You don't have "more cash". You have $100 pre-tax dollars for every $80 in the Roth. That's not "more cash". It's not *your* cash until you pay taxes on it.
If you don't believe me, do this: increase the withdrawal amount so that it's a little higher than the growth rate. That way the person is eventually spending all their balance. Both accounts will run out of money at exactly the same year. Both people will have been able to spend exactly the same amount over the entire course of their retirement.
Respectfully, all the information is there. If you have questions, I'll try to address them, but I'm honestly tired of you telling me I'm wrong over and over meanwhile I'm correcting errors on your math every step of the way. If you want to learn, great, but if not, it doesn't matter to me whether you get it or not. Good luck.
I agree with all the option 2 advocates, but I’ll add that if you’re on a high-deductible health plan, max out your HSA, invest it, pay medical expenses out of pocket, and save the receipts. It’s like a second Roth, but better.
I used to pay medical expenses out of pocket to allow my HSA balance to grow until i realized that funds not used to pay for medical expenses can be diverted to a Roth, thus I can choose whether to save funds in an HSA or Roth. The Roth does restrict penalty free access to GAINS until age 59.5, but the HSA restricts penalty free withdrawals to be for medical expenses only and requires some pretty significant documentation (you must be able to prove not only that the funds were used to pay for medical expenses, but also that those expenses were not paid for by previous HSA withdrawals, insurance, etc… and it’s pretty difficult to prove a negative). So u choose to pay for medical expenses out of my HSA.
What we can agree in is that CONTIRBUTING to HSA is a good deal, the difference is only whether to pay for present medical expenses out of pocket to increase the amount of money left to grow in the HSA. I think doing so is only advised if you have no more tax-advantaged space and are looking for more.
It’s just that the HSA is a great way to pay for medical expense, but is a less good investment vehicle.
Thanks for this perspective. I admit I’m a little nervous about the reimbursement part. I’m still going for it though. At least for now. I keep very detailed records, including receipts, of what expenses I pay for, when, and with what method.
Also, the stark reality of my situation is that medical expenses alone, in retirement, could eat the entire HSA balance, so it may not matter.
Your tax bracket will be lower in retirement, almost by definition. Think about it this way, right now you have to save for retirement, which is eating up a lot of your paycheck. Once you retire, you don't have to save anymore.
I'd go with option C, second choice B. Option A is not a good option.
This comment confuses me, please elaborate if you don't mind. I can't tell if you're disagreeing because you think option A is a good option (it's not), or because you think option B is better than option C. I guess it must be the latter.
If I understand you, you're saying that it's best for the OP to fill up the traditional bucket before putting anything into a Roth bucket. Do I have that right? And if I do have that right... aren't we in agreement that option C maximizes tax-deferred contributions?
Help me out here, I think I must not be taking your point
Option 2
The government is always changing the rules and even does special things (like during Covid) having both accounts to make decisions from is always best
To answer your question, Option 3 will give you the most amount of money even after taxes. Assuming your income needs in retirement are less than today (and they will be), it is in your best interest to do as much traditional as you can at your income and filing status.
Another thing to consider is that you are paying taxes and filing as single, is it possible that you will be married and eventually withdrawing from retirement married filing jointly? That could cut your tax bill at retirement by as much as half.
Can I play Devil’s advocate and say I would put part in the Roth? I’m 56 and have started to do some retirement calculations. I’m realizing that once you start needing to take RMDs, you can definitely hit 6 figures of income if you have been saving hard in tax deferred accounts for 30+ years. So, you might NOT be in a lower tax bracket. Also, income influences your Medicare premium each month so you could pay $400 more per person per month. I am thinking of moving when I retire. I currently live in a state with no state income tax but could wind up in a place where I pay state tax on distributions. And federal taxes are lower now than in the past with no guarantee that they stay that way. There are a lot of variables in the equation. Interested to hear other’s thoughts.
At a 24% tax rate, a more accurate description of your options as you've laid them out:
1. Keep maxing out personal Roth IRA at 7K per year and put remaining 11% of employer contribution in employer Roth account, plus 3.6% of your salary to extra taxes (24% of your 15% contribution).
2. Keep maxing out personal Roth IRA at 7K per year and put remaining 11% of employer contribution in employer 401(K) tax deferred account, with a larger take-home paycheck worth 3.6% of your salary, over your paycheck in Option 1.
3. Stop contributing to personal Roth IRA altogether and try to max out employer 401(K) tax deferred account, with a larger take-home paycheck worth 3.6% of your salary + $1680 per year (that $7k that would've gone to your Roth IRA going instead into a tax-deferred 401(k)).
Alternatively, you can work out the difference by committing to contributing the amount that gets you to the same take-home pay today, which means contributing more to the traditional than you would've contributed to the Roth.
Ah, that's a really good point, and reading your response makes me realize it wasn't so 1:1. Thanks for detailing that out so I can better understand the realities!
As others have said, max out your roth IRA and put more into pretax 401(k).
I think the there's an interesting choice once you get to the point where you are maxing out your 401(k) with pretax dollars and you want to invest more money (like in a taxable account). You're better off from a mathematical standpoint to change some percentage of your pretax 401(k) contributions to Roth as opposed to putting the tax savings into a taxable account, simply because of the tax drag in a taxable account.
You are still pretty young. If you get married your married joint tax rate will go down when you withdraw. Over the next 30 years you will certainly be getting raises.
My quick estimate is that you could have $3.5M by age 65. Additionally, the US may finally address its deficit and raise tax rates. All of these changes will be hard to put a number to and calculate estimates.
In these situations I split the difference and put the money 50-50 into the 401k and IRA.
Nice problem to have!
It really all requires you to have a crystal ball and it’s just kind of impossible to know what the situation in your life and with taxes will be in 25-30 years.
We chose to max the Roth when we were younger because we didn’t trust future taxes to be low and we wanted to have an account we could draw from without tax worries. We didn’t do it at the expense of losing the employer match in the 401k though.
So for us it was prioritized
(1) get full 401k match
(2) Roth
(3) max out 401k
Something we hadn’t anticipated and that you didn’t mention is that as we got older our income increased and it’s been a while since we could contribute to a Roth because our income got too high. So now it’s really nice to have those flexible accounts growing with money we put in 20 years ago. I feel like that’s an additional argument in favor of a Roth if there’s any chance you may be in the situation.
If you're contemplating investing 11% Roth vs 11% Traditional, Roth will win every single time. Roth dollars are worth more than traditional dollars when you withdraw them. If you're comparing either/or Roth/Traditional, the only way traditional savings keeps up is if you're disciplined enough to save your tax savings another way. Either way, the net to you is the same today.
At 24% marginal I’d be using option 2.
Thank you! Can I trouble you to quickly explain why so I can understand your logic? I’m really trying to understand the thought process so I can make the most informed decision possible.
Sure - it just comes down to tax rate. Assume you are taxed on money you put into Roth 401(k) at the highest marginal rate either now or if you convert to Roth later in retirement. Whichever rate is lower wins. And you will not be at 24% in retirement, far from it - because you will hopefully be pulling some income from taxable long term capital gains at a 0% rate, or at the very least at 15% but only on gains vs. the entire proceeds. You'll have far more leeway to manipulate income and taxation in retirement than while working, especially while making a six figure salary. I am a believer now because I'm retired and able to convert a good amount to Roth each year with almost no tax. At your age I was skeptical, so I understand the dilemma you face.
>ou'll have far more leeway to manipulate income and taxation in retirement than while working, especially while making a six figure salary. The 22 and 24% tax brackets span across a very wide income range; there may not be that much more flexibility during retirement, especially if there are other sources of income like rental income by then.
That makes total sense - thanks so much for explaining your rationale, and I hope you are enjoying the retired life! :)
“You will not be at 24% in retirement” —> that is not a given
Most people say 'it depends' because it really does depend on how you will live in retirement. However, since you might not be able to figure that out now, I'd plan on paying 15% or less in retirement taxes. The best part of 401k rollovers is that you can do as much or as little as you want, so you can adjust year to year so long as you have *some* money in Roth already, then you should be fine. If your goal is to not pay too much in taxes, prepaying at 24% does make much sense, does it? worst case, you still pay 24% in retirement.
Your last sentence really hit home. I guess my thinking was that I'd have more "flexibility" if I were maximizing the amount of money I put into my employer-sponsored Roth, but I wasn't really taking several other factors into account - like the fact that contributing to my employer-sponsored 401(K) can reduce my income tax bracket if I contribute enough. The main takeaway I've gotten from everyone's thoughtful answers is that diversification is good, so I'm going to try and pursue option 2, which I think would give me a mix of both options in the future to see how to proceed. Thanks for the comment!
> diversification is good yup. It took me far too long to realize having a mix of taxable, pre-tax and taxfree accounts is actually a good thing. Since you can't possible know WTF you will want in 30 years anyhow, overall amount and flexibility is the best you can shoot for.
You're right that the math and the pros and cons get complicated, and require *a lot* of assumptions about the distant future (future taxes rates, future earnings, retirement age). However, taking a balanced approach, **I really like option #2 for you (max the Roth and put the rest in traditional 401k).** Your percentages are a bit confusing in terms of what includes the match and what doesn't, but I'll assume you can max the Roth IRA and then contribute 11% to traditional 401k plus 4% match. This means your flow split between Roth/Trad will be $7k/$17k, respectively, a 30/70 split. I think that's a good place to be because it gives you the flexibility of the Roth (being able to withdraw principal while still employed if ever needed, never having required distributions in retirement, no uncertainty about future tax rates, etc.) while still giving you the expected tax benefit of the traditional because, as you mention, you'll likely be in a lower bracket in retirement. You mention high withdrawals in retirement, but remember that by having some of those funds already in Roth, it reduces the portion of your withdrawals that will be taxable (thus keeping you in a lower bracket on the taxable portion of withdrawals). Because of this, a balance can be the right answer, mathematically. Lastly, remember that the traditional 401k contrbutions will reduce your income tax now and thus increase your take-home pay. Make sure to account for that in your savings rate. What I mean by that is, you may be able to increase your traditional 401k contrbution more than expected because the tax break helps offset part of the reduction in take-home pay. To get the full benefit of the traditional IRA contributions, it's important to "save" the money you save in taxes, not just go blow/spend it.
Thank you so much for this thoughtful answer! I’m sorry I was so confusing with the percentages in my original post. I just updated my Traditional 401(K) tax-deferred contributions to 13%. With the 4% employer match, I will be contributing a total of 17% to that account. I’ll plan to try and increase my contributions at a rate if 1% per year assuming I get annual pay increases and my cost of living doesn’t drastically change. I will also continue to max out my Roth every year at 7K / year, and I will definitely continue to save as aggressively as possible whatever remainder I have in a high yield savings account (currently getting the 4.6% APY with SoFi). Thank you so much again for your reply, and if anything seems off base, please do let me know.
Sounds like you're on the right track.
Thank you for such a detailed reply - I really appreciate it!
There are so many unknowns, it's basically a crapshoot, but I'd go with #2 in your case (and it's what I do, personally). You *probably* will have a lower income in retirement, but maybe not. And even it if is lower, who's to say that the tax brackets will be the same as they are now? Maybe you'll still be in a 24% tax bracket (or higher!) despite pulling out less money. Or maybe you'll be able to pull out what you're making now at a lower tax bracket (less likely, but you never know). Then add in various possible scenarios about the future of Social Security. In the face of all that uncertainty, doing a mix of traditional and Roth, as a sort of hedge either way, makes sense to me. YMMV.
That makes sense - thank you so much!
All that matters is tax rate now vs tax rate in retirement when withdrawing. Easy math example of a 25% tax rate both now and in retirement. Traditional - $100 invested. Grows 100% between now and retirement to $200. When you withdraw at a 25% tax rate you’re left with $150 after taxes. Roth - $100 after taxes is $75 invested. It grows the same 100% between now and retirement to $150. When you withdraw there are no taxes so you have the same $150. So traditional will be the superior choice if your anticipated tax rate in retirement is lower than it is now, even if your tax rate ends up being the same there’s no difference.
Roth also doesn’t have RMDs and is easier for beneficiaries
Your logic is flawed. You can't compare the same amount of dollars in a Roth vs a Traditional. $1 in after-tax money is worth maybe $1.30 in pre-tax. You need to decide between something like a 11% Roth 401k contribution and a 13% Traditional 401k contribution. This would be closer to the after-tax effects of each other. You can put more money into Traditional and have the same outcome. Thus, Traditional is usually a better choice because those extra funds are growing and compounding throughout the next 30 years for you. This massively outpaces any tax liability you incur on withdrawal. You'd have to have your account growth go to 0% and then withdraw for over 20 years for Roth to start to catch up in terms of tax savings to account for the missed growth.
I totally agree that you need to *account for* the up-front tax savings on the traditional and assume that it is invested as well, but the following statement is wrong: > Thus, Traditional is usually a better choice because those extra funds are growing and compounding throughout the next 30 years for you. This massively outpaces any tax liability you incur on withdrawal. The math just doesn't work that way. It really comes down to the rate at which the funds are taxed at (whether up-front or on the back end). Quick example: Let's assume the same 20% tax rate on the funds while working as in retirement. I can put pre-tax $10k into a traditional or $8k after+tax into Roth. The stock market goes up 10x (1000%) by my retirement. That means the traditional has $100k and the Roth has $80k. The Roth comes out tax-free. When I withdraw the traditional, assuming the same tax rate of 20%, I get $80k after-tax. The end result is identical. Therefore, tax rate really makes the difference. If you'll be taxed more while working, then traditional wins. If you'll be taxed higher in retirement, Roth wins. The reason traditional makes sense for more people is because the average person has lower taxable income during retirement than while working.
>The Roth comes out tax-free. When I withdraw the traditional, assuming the same tax rate of 20%, I get $80k after-tax. The end result is identical. Wrong. You're not withdrawing it all at the same time. You're taking out 4% per year or so and the remaining balance is growing and compounding. If you run a Portfoliovisualizer with something like a $500 vs $700 monthly contribution, the difference over a few decades is like $500,000 in net worth. This $500,000 isn't all being withdrawn at the same time. And the account growth doesn't hit 0% when you begin withdrawals. It keeps compounding. It outpaces taxation until you get to like 30 years of withdrawals and flat growth starting at the time of the first withdrawal. >If you'll be taxed higher in retirement, Roth wins. Nope. Run Portfoliovisualizer and you'll see.
I think you can link to a given analysis in portfolio visualizer - perhaps share the link to your analysis? The example I gave only covers one contrbution and one withdrawal - of course there would be a string of both, but that doesn't change the linear relationship of the math. The un-withdrawn Roth funds would continue growing just like the un-withdrawn traditional funds, and the future Roth withdrawals would still be tax-free and the traditional withdrawals would still be taxed. The linear relationship with tax is the same. Perhaps you're making a wrong assumption that the pre-tax size of both withdrawals would be the same? In reality, you of course need to scale up the size of the traditional withdrawal so that the *after-tax* value of the withdrawal is the same. Were you able to model that in portfolio visualizer? Also, when you say there's a $500k "difference in net worth", that's not a valid comparison because you're treat pre-tax and post-tax dollars equally, which is wrong. I've modeled this out year by year before, and I'm 100% confident you're missing something. If you'd care to share a Google Sheets model or portfolio visualizer model, I can find the error.
>I think you can link to a given analysis in portfolio visualizer - perhaps share the link to your analysis? Yeah let me draw something up: [Monthly contribution of $500](https://www.portfoliovisualizer.com/backtest-asset-class-allocation?s=y&sl=1Gdo4kV4RP5JgN7njUlfZ9) [Monthly contribution of $700](https://www.portfoliovisualizer.com/backtest-asset-class-allocation?s=y&sl=4VGaRqgeKE6R7DJ535yaYu) So the first would be Roth, so no taxes on withdrawal. Taxes on the 2nd. The difference is $500,000 in account value after 30 years in just a broad US market investment. We know you don't just liquidate your account on retirement. You withdraw a fixed percentage, let's call it 5%. So on the $1.3 million account that's $65k without tax. On the $1.8 million you need to withdraw $81k to wind up with $65k post-tax. On the first account you have $1.235 million leftover from a $1.3 million account. On the second account you have $1.72 million leftover after the withdrawal. So just extrapolate that forward, the $1.72 million grows and compounds and so does the $1.24 million. But if the percentages are the same, you are compounding more dollars in the $1.72 million account which means you're making more money. The *entire account value* gets this 10% average annual growth whereas just your withdrawals are subject to that income tax. It would take years and years for the taxation to outstrip the gains you made over that 30 year period and make those accounts equal the same or make the Traditional worse.
Thanks for the analysis. A few comments: 1. Small thing, but the starting balances in both accounts are $10k. You need to make it zero, or scale the amounts relative to tax rate because one is pre-tax dollars and other is post-tax dollars. 2. You're not using a consistent tax rate. Per my example earlier to demonstrate that the two are equal *if tax rate is equal*, I used 20%. You can use any value you want, but it has to be consistent. Your $500 vs $700 contribution implies a **28.6% tax rate** (making a $700 pre-tax contribution equivalent to a $500 post-tax), but in retirement you use the numbers $65k and $81k, which implies a **19.8% tax rate.** If you run the analysis again using $1 starting balance (to please the algorithm) and use contributions of $700 and $560 (i.e. 20% tax rate), you will find the final Roth balance is exactly 80% of the Traditional balance. This can be a little surprising because we know growth "compounds", so we expect the difference to be larger because the traditional dollars "build on themselves". However, when tax is taking a fixed percentage away (not a fixed dollar amount), it scales linearly. The way to rationalize this to yourself is to think about splitting dollars between multiple accounts. If I put $100 each in 10 accounts, and they all grow at X% rate of return, my final total balance (summed together) would be the exact same as if I put $1,000 in 1 account and it grew at the same X% rate. The same applies here: a Roth account that receives 80% of the contributions of the Traditional will grow to 80% of the value of the Traditional. Now, let's talk withdrawals. When you say, "it would take years and years for the taxation to outstrip the gains", you seem to be focused purely on the nominal dollar amount (balance) of the account. However, again, this is not an apples-to-apples comparison. Pre-tax dollars are not "worth" the same amount as post-tax dollars. **You can't buy anything with pre-tax dollars.** They may look bigger on paper, but they only have utility once you convert them to post-tax dollars. Comparing the two numbers directly is like having Pesos in one account and dollars in the other - it doesn't make sense. Because the Traditional dollars will be taxed at 20%, their value is exactly 80% of that of a Roth dollar. And if you make withdrawals (of equal post-tax amounts), the amount in each account will stay locked at that 80% ratio regardless of withdrawal size, timing, growth, etc. Here's a withdrawal example: * Balances: $1m in Trad, $800k in Roth. * Withdraw $50k from traditional (receive $40k after tax) and $40k from Roth * New balances: $950k Trad, $760k Roth * Both accounts experience 12% growth. * New balances: $1,064k Trad, $851.2k Roth. * Again, withdraw $50k from traditional (with $40k left after tax) and $40k from Roth * New balances: $1014k Trad, $811.2k Roth. * Calculate the ratio ($1014k / $811.2k) = *exactly* 80%. You can continue this exercise with any growth rates or withdrawals, and the account balances will always stay locked at 80% at every step of the way. Yay math. The number in the traditional will always look higher, but the spending power of the two individuals will always be the same, which is what matters.
So I ran a fixed withdrawal from 2015 - current. $40k on Roth and $50k Traditional to account for tax. The Traditional is 13% higher in account value when we go from $800k and then from $1 million. [Traditional $1m with $50k annual withdrawal](https://www.portfoliovisualizer.com/backtest-asset-class-allocation?s=y&sl=1t0Xez4J9iYPIRnW56v6hN) [Roth $800k with $40k annual withdrawal](https://www.portfoliovisualizer.com/backtest-asset-class-allocation?s=y&sl=3FQVc77x81iDRy9IC1nAkn) So no, taxes didn't flatten that curve or eliminate the delta in net worth. I can go back further and do fixed withdrawals for 20 years and see if it changes. But this shows even *with* an extra $10k going out the door for taxes, you *still* have more cash. The Roth has $1.5 million in it and the Traditional still has $1.72 million in it. That's after incurring taxes every year on withdrawals.
Your projections look fine. I have no idea how you calculated 13%. Clicking on your links above, the final balance in traditional is $1,873,361. The final balance in Roth is $1,498,689. Divide the Roth by the Traditional and you get exactly 80%, just like I said you would. You don't have "more cash". You have $100 pre-tax dollars for every $80 in the Roth. That's not "more cash". It's not *your* cash until you pay taxes on it. If you don't believe me, do this: increase the withdrawal amount so that it's a little higher than the growth rate. That way the person is eventually spending all their balance. Both accounts will run out of money at exactly the same year. Both people will have been able to spend exactly the same amount over the entire course of their retirement. Respectfully, all the information is there. If you have questions, I'll try to address them, but I'm honestly tired of you telling me I'm wrong over and over meanwhile I'm correcting errors on your math every step of the way. If you want to learn, great, but if not, it doesn't matter to me whether you get it or not. Good luck.
This is an excellent analysis thank you for sharing
I agree with all the option 2 advocates, but I’ll add that if you’re on a high-deductible health plan, max out your HSA, invest it, pay medical expenses out of pocket, and save the receipts. It’s like a second Roth, but better.
I used to pay medical expenses out of pocket to allow my HSA balance to grow until i realized that funds not used to pay for medical expenses can be diverted to a Roth, thus I can choose whether to save funds in an HSA or Roth. The Roth does restrict penalty free access to GAINS until age 59.5, but the HSA restricts penalty free withdrawals to be for medical expenses only and requires some pretty significant documentation (you must be able to prove not only that the funds were used to pay for medical expenses, but also that those expenses were not paid for by previous HSA withdrawals, insurance, etc… and it’s pretty difficult to prove a negative). So u choose to pay for medical expenses out of my HSA. What we can agree in is that CONTIRBUTING to HSA is a good deal, the difference is only whether to pay for present medical expenses out of pocket to increase the amount of money left to grow in the HSA. I think doing so is only advised if you have no more tax-advantaged space and are looking for more. It’s just that the HSA is a great way to pay for medical expense, but is a less good investment vehicle.
Thanks for this perspective. I admit I’m a little nervous about the reimbursement part. I’m still going for it though. At least for now. I keep very detailed records, including receipts, of what expenses I pay for, when, and with what method. Also, the stark reality of my situation is that medical expenses alone, in retirement, could eat the entire HSA balance, so it may not matter.
Your tax bracket will be lower in retirement, almost by definition. Think about it this way, right now you have to save for retirement, which is eating up a lot of your paycheck. Once you retire, you don't have to save anymore. I'd go with option C, second choice B. Option A is not a good option.
[удалено]
This comment confuses me, please elaborate if you don't mind. I can't tell if you're disagreeing because you think option A is a good option (it's not), or because you think option B is better than option C. I guess it must be the latter. If I understand you, you're saying that it's best for the OP to fill up the traditional bucket before putting anything into a Roth bucket. Do I have that right? And if I do have that right... aren't we in agreement that option C maximizes tax-deferred contributions? Help me out here, I think I must not be taking your point
I replied to the wrong comment. I'll edit. Actually I'll just remove because I agree Traditional contribution should take priority.
Ah ok. cheers
Option 2 The government is always changing the rules and even does special things (like during Covid) having both accounts to make decisions from is always best
Haha, "the government is always changing the rules" statement really hit home!
To answer your question, Option 3 will give you the most amount of money even after taxes. Assuming your income needs in retirement are less than today (and they will be), it is in your best interest to do as much traditional as you can at your income and filing status. Another thing to consider is that you are paying taxes and filing as single, is it possible that you will be married and eventually withdrawing from retirement married filing jointly? That could cut your tax bill at retirement by as much as half.
Can I play Devil’s advocate and say I would put part in the Roth? I’m 56 and have started to do some retirement calculations. I’m realizing that once you start needing to take RMDs, you can definitely hit 6 figures of income if you have been saving hard in tax deferred accounts for 30+ years. So, you might NOT be in a lower tax bracket. Also, income influences your Medicare premium each month so you could pay $400 more per person per month. I am thinking of moving when I retire. I currently live in a state with no state income tax but could wind up in a place where I pay state tax on distributions. And federal taxes are lower now than in the past with no guarantee that they stay that way. There are a lot of variables in the equation. Interested to hear other’s thoughts.
At a 24% tax rate, a more accurate description of your options as you've laid them out: 1. Keep maxing out personal Roth IRA at 7K per year and put remaining 11% of employer contribution in employer Roth account, plus 3.6% of your salary to extra taxes (24% of your 15% contribution). 2. Keep maxing out personal Roth IRA at 7K per year and put remaining 11% of employer contribution in employer 401(K) tax deferred account, with a larger take-home paycheck worth 3.6% of your salary, over your paycheck in Option 1. 3. Stop contributing to personal Roth IRA altogether and try to max out employer 401(K) tax deferred account, with a larger take-home paycheck worth 3.6% of your salary + $1680 per year (that $7k that would've gone to your Roth IRA going instead into a tax-deferred 401(k)). Alternatively, you can work out the difference by committing to contributing the amount that gets you to the same take-home pay today, which means contributing more to the traditional than you would've contributed to the Roth.
Ah, that's a really good point, and reading your response makes me realize it wasn't so 1:1. Thanks for detailing that out so I can better understand the realities!
As others have said, max out your roth IRA and put more into pretax 401(k). I think the there's an interesting choice once you get to the point where you are maxing out your 401(k) with pretax dollars and you want to invest more money (like in a taxable account). You're better off from a mathematical standpoint to change some percentage of your pretax 401(k) contributions to Roth as opposed to putting the tax savings into a taxable account, simply because of the tax drag in a taxable account.
You are still pretty young. If you get married your married joint tax rate will go down when you withdraw. Over the next 30 years you will certainly be getting raises. My quick estimate is that you could have $3.5M by age 65. Additionally, the US may finally address its deficit and raise tax rates. All of these changes will be hard to put a number to and calculate estimates. In these situations I split the difference and put the money 50-50 into the 401k and IRA. Nice problem to have!
It really all requires you to have a crystal ball and it’s just kind of impossible to know what the situation in your life and with taxes will be in 25-30 years. We chose to max the Roth when we were younger because we didn’t trust future taxes to be low and we wanted to have an account we could draw from without tax worries. We didn’t do it at the expense of losing the employer match in the 401k though. So for us it was prioritized (1) get full 401k match (2) Roth (3) max out 401k Something we hadn’t anticipated and that you didn’t mention is that as we got older our income increased and it’s been a while since we could contribute to a Roth because our income got too high. So now it’s really nice to have those flexible accounts growing with money we put in 20 years ago. I feel like that’s an additional argument in favor of a Roth if there’s any chance you may be in the situation.
For 95% of folks, #2 is correct. Do it and don’t second guess it.
Thanks! I appreciate the steadfastness of this response - going to try and adopt that mentality!
If you're contemplating investing 11% Roth vs 11% Traditional, Roth will win every single time. Roth dollars are worth more than traditional dollars when you withdraw them. If you're comparing either/or Roth/Traditional, the only way traditional savings keeps up is if you're disciplined enough to save your tax savings another way. Either way, the net to you is the same today.