They each have their own unique advantages. Everyone should custom tailor their contributions and savings to the specific point in time of their investment/income lifecycle
You should take advantage of Roth contributions, especially when you are younger and the calculation is a no brainer
As your earnings grow so will your investments along with the taxes due on them (unless of course you already paid them).
You’re probably too young/poor to imagine a massive 401k balance. But when mandatory retirement age hits you’re going to wish you paid taxes up front. Which by the way Roth 401k/IRA is not subject to RMDs. Of course you can avoid this by spending down your entire 401k balance by age 72, but then you have $0 in your 401k and have to rely on whatever else you have squirreled away in non tax advantaged accounts
You’re going to want a combination of traditional and Roth retirement holdings or you’re going to have to make a growing RMD each year, even the market tanks. You naively planned to “just live on less”, but the tax man gets their share - he always does
Hypothetically if someone invested $10K in Apple stock in the late 1990s it might be worth $1M today.
Lets say that someone now wanted to sell said stock.
Would you be better off it was in a traditional 401(k), a regular after tax brokerage, or a ROTH 401(k)?
Assume your tax on that 10K back in 1990 would have been $4K which is probably not accurate but let me know which you’d rather have today and why. Any answer that isn’t ROTH will need so serious hand waving.
If it’s in a regular 401(k) you got a $4K tax deduction back in the 90s but now owe tax on ordinary income of $1M @ the 40% we’ve been throwing around that’s $400K.
If it’s in a regular brokerage lets say you reinvested the dividends and the basis is now $50K and along the way you paid taxes on the $40K in dividends and we’ll ignore that. But you LTCG rate is 20% instead of 40% and you don’t get taxed on the $50K basis. so 20% on the $950K gain would be $190K.
Now let’s say that’s in a ROTH the taxes are $0.
Hum I don’t know about you but I know where I’d like that invested if I had a time machine.
Different people are in different situations. I speak as a retiree where Roth’s were not available for much of my working lifetime, and I did not use them even after they became available.
Now in retirement and seeing the effect of Required Minimum Distributions from the Traditional IRA, I have recently being converting enough of the Traditional IRA to Roth each year to max out my current marginal tax bracket. Without conversions, some of the income would have moved into a higher marginal tax bracket as RMDs would have increased with age.
It was a mistake not to start conversions before RMDs started. In some post-retirement years, my marginal bracket was lower than the current one.
Since most of my current conversions are shifting within the same tax bracket, part of the motivation is an expectation that tax rates will increase.
If you had 10k in the 1990s, you could buy 10k worth in your pre-tax 401k. You could only buy 6k worth if you use a Roth or post tax account. Not fair to compare 10k worth of pre-tax against 10k worth of post tax.
This is technically correct, but not really useful in the sense that most people would use their retirement plan. Nobody should have a plan that 100% of his or her traditional IRA gets dumped through the tax gate in a single year of retirement.
A much more optimal plan, IMHO, is to take that 1M out 58.5k at a time over a period of 18 years or more. 58.5k is an amount chosen to effectively exhaust the single person tax structure of 0%, 10%, 12% progressive tax structure on the 1st 13,850, the next 11,000, and the next 33,725 (2023 tax brackets). THat means that the average tax is ~8.8%, not 40%, because the revenue was stretched out for living expenses over many years to defer the recognition of the income and make the most use of the lowest tax brackets over time. {And yes, I understand that the tax brackets get adjustments over time and congress could change them down the road, but this is supposed to be heuristic}
In this more optimal plan, 8.8% is a lot less tax burden than 40%.
It would help if you would start off by the comparison you are actually making.
The earlier question (and in fact the entire point of this thread) was comparing traditional to Roth. Capital gains tax is irrelevant on both. If you hold the tax rate constant and make the same pretax contribution then the two come out the same. So you’re really just comparing your current and future tax rates with a side of having a higher contribution limit with Roth.
You appear to be making a completely different comparison which is comparing Roth to a non-tax-advantaged account, which is a different comparison altogether. No one was asking whether tax-advantaged retirement accounts are better than non-tax-advantaged accounts.
Due to the tax-free nature of withdrawals, it is common parlance to refer to Roth IRAs and Roth 401Ks as tax-advantaged. (Also traditional IRAs & 401Ks due to the tax deduction when you contribute)
I want to make sure this bolded portion is not misinterpreted. Yes, the difference between Traditional/Roth just comes down to comparing the ultimate tax rates. However, what determines your future tax rate are far more factors than whether the tax rates change. A lot of people reduce this guidance to “if the tax rates increase in the future then Roth would have been the better bet” and that is simply not true.
If my tax rate hits 40%, I’ll likely be doing Traditional investments. But right now I’m not paid that much, so I must be too stupid to understand. I’m going to continue with enough Traditional to avoid the next marginal bracket and Roth beyond that.
Yes, a number of things can cause your current and future tax rates to be different. A material change to the tax code, Congress simply increasing or decreasing the tax rates, inflation causing an ever greater share of your Social Security benefit to be taxed since the values in the formula have not increased since 1982, your income being higher or lower, your deductions being higher or lower, etc.
I agree. One notable edge case is low earners with access to money. If your kids earn money while still young with part time employment, their federal income tax is often 0. Putting all their earnings into a roth is a great tax avoidance plan.
Another is a person’s first year of a career job. Oftentimes you start mid year due to graduation, so marginal rate in a mid-range job will be low tax rate. Probably not for i-bankers, but fir some folks.
When my kid is working (because they will have a job), I plan to “take their money” and put 100% of it into a Roth IRA, then give them an allowance of 100% of their wages. (Realistically I’ll just drop money in but this should be totally legal I understand.)
I mean it’ll be like $300 for 30 hours worked in a month, NBD to me, start the kid off amazingly well.
This is the important one. Roth contributions are taxed at your marginal rate, whereas the Traditional withdrawals are taxed at an average of 0%/10%/12%/etc.
Practically, Trad vs Roth (imo) comes down to RMD minimization. If you can minimize your RMDs to a level where your withdrawals after age 72 aren’t materially different than those before 72, Traditional probably came out ahead.
It is not valid to compare a 10k investment in a tradtional to a 10k invested in a Roth. It is a better comparison to compare 10k in a traditional with 6k invested in a Roth, because ROTH money has to go through the tax gate to get into the Roth account
In a traditional, I will take my $10k and buy the stock and it gets to 1M value and I take out 58.5k over 18 years and end up paying 8.8% effective income tax rate on the 1M. I end up with an annuity of at least 18 years (likely more if the stock continues to appreciate) that pays me at least 912,000 net of taxes.
For a Roth, I only get to buy 6k worth of stock because I had to pay 40% of the 10k in taxes. My stock reaches a value of 600,000. I can use it at any time and No, I don’t have to pay any capital gains taxes on the appreciation. But my point here is that if this had been a post tax brokerage account, you would not owe INCOME taxes on the appreciation either, you would owe CAPTIAL GAINS taxes on the appreciation, so the tax benefit of the ROTH is avoidance of those capital gains taxes.
But the fact that I get 100% of the 600k whereas with the traditional I only got 91.2% is not a comparison that is worth making. With a traditional, I got 91.2% of the GROSS amount. With the Roth, I got 100% of the net.
The comparison of a traditional vs Roth should be which one best optimizes the minimization and delay of tax payment.
A traditional plan defers taxes to a points in time when the marginal rates on the funds will be much lower.
A Roth does not delay income tax at all. You pay your full marginal rate now on the funds in order to avoid having to pay capital gains taxes on the appreciation in stock value.
So 912,000 > 600,000. SO I think that traditional is better.