Yep, so long as the amounts you’re talking about are not in gift tax territory. In 2024 that’s $18,000… or $36,000 if you are married, so presumably not an issue if you’re talking about a child’s earnings.
I don’t know if it really changes the analysis any, but technically speaking, I think you put in the same amount to the Roth as the Traditional. Rather than saying it’s $10k in a Traditional vs $6k in a Roth, I think the more correct comparison is $6k in a Roth vs $6k in a Traditional + $4k in a Brokerage.
Traditional withdrawals are taxed as ordinary income, so essentially also the marginal rate, just in a different tax year.
What exactly is “the” marginal rate when we are talking about taxes on ordinary income?
Whatever assumptions you make about your tax rate now and later will drive which is the better outcome.
If you assume a 25% tax rate now AND in retirement (or a 10% tax rate or a 37% tax rate… doesn’t matter so long as it’s the same on both dates) then it will come out exactly the same on the same pre-tax investment.
The only differentiators are differing tax rates between now & retirement (which can differ for a large number of reasons) and RMDs and the fact that you effectively have a higher contribution limit with Roth.
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Yes good point seeing as most high income investors will contribute the maximum allowable amount. But then the brokerage investment is made with after tax dollars so $4k is reduced to $2.6k
With capital gains tax on dividend payments every year unless you invest in something like Berkshire Hathaway
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The issue here is that you pay tax on the Roth.
So if you have $10,000 and are paying 40% marginal taxes then your choices are:
A) $10,000 into a Traditional retirement account
B) $6,000 into a Roth account and $4,000 to the federal & state governments
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That’s not how my Roth 401k works. Maybe IRA’s are different, but for purposes of most of this discussion I’ve been assuming this is a Trad vs Roth 401k discussion, given most actuaries are probably not eligible to be contributing to Trad IRAs.
Revision before this is muddied. Trad IRAs have no income limit. Roths are $228k for filing jointly.
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Basically the question is, can you afford to pay the tax to max out $10k in the Roth. If your marginal tax rate is 40%, I would hope the answer would be “yes”…
Yes, that is precisely how your Roth 401k works unless your employer is violating federal law.
Your Roth 401k contributions are taxed as ordinary income. If your marginal tax rate is 37% federal and 3% state then contributing $6,000 to Roth will leave you with the same net pay as contributing $10,000 Traditional.
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So really, the play is to work in whichever state allows maximal post-tax income and retire in a state that doesn’t tax retirement accounts.
Still going to get dinged hard by the feds. Hey, maybe in 20+ years Texas won’t suck and I’ll move there.
But you can also contribute $6k to the Roth and have lower net pay than a $6k contribution to a Traditional account. Which is why I thought the better comparison point to DeepPurple’s post was $6k Roth vs $6k traditional + $4k brokerage.
Again making some implicit assumptions here, but I’m assuming we’re talking about maximizing retirement account contributions. So when deciding on the margins between Traditional and Roth, you should be planning on the amount of money contributed to those accounts be the same.
Everyone who has earned income or taxable wages is eligible to contribute to an IRA unless you are over the RMD age.
You may make too much to make a ROTH-IRA contribution.
You may make too much to make a deductible IRA contribution.
But you can always make an after-tax IRA contribution creating a basis in your IRA than can make later withdrawals fun to calculate the taxable amount. Or set up possible back door ROTH conversions if you don’t have other IRAs.
I don’t agree with you.
To male any valid comparison, the true comparison must be inclusive of all taxes and the timing thereof.
It’s not at all fair to compare a constant number of dollars in a Roth vs the traditional. Roth dollars have gone through the tax gate, so there are fewer of them. In our example, the fair comparison is 10k now (Tradtional) and 6k now (Roth) because on a Roth, Uncle Sam gets 4k real dollars at the time of deployment.
If you wrongly compare 10k now in a tradtional and 10k now in a Roth, of course a Roth would win. There is no downside to a Roth in that comparison, because you have omitted the only significant downside that the Roth has: You must pay full marginal rates to fund the account.
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I presume you mean “lower pay net of taxes”, because usually “net” refers to “tax”.
Contributing to a Roth instead of Traditional gives you higher net pay. You also pay more income tax contributing to a Roth, while also getting more net pay.
You do get less money in your pocket for putting anything into retirement.
It’s also not really valid to to assume folks will invest the current “tax savings” of traditional in another savings vehicle. Most folks simply don’t do that. They spend it on hookers and blow, the rest they just waste. Sure there are probably a few actuaries who say hey I saved $4K in taxes by making this year’s 401(K) contributions so I’m going to invest those savings in an after tax brokerage account.
No most people fill out the form and say sure take 5% of my pay and put it into my 401(k), most don’t care if its pre-tax or ROTH, they just simply adjust their spending to whatever their take home pay is.
But if you compare apples to apples then ROTH and Pre-Tax will come out the same if tax rates remain constant. That is if you compare (Pre-Tax) to (ROTH - minus the prepaid taxes) then ROTH withdrawals with no taxes will be the same as Pre-tax subject to taxes since you need to gross up the withdrawal to pay the taxes later.
Now the fact that tax rates aren’t constant, the fact that tax rates are progressive, and the fact that diffrent types of gains are subject to different tax rates all change the nature of the calculations and gives a lot of wiggle room to optimize for a given individual.
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You’re completely ignoring the additional $ going into a brokerage account in the scenario where you contributed to a Traditional.
You are acting as if you are not allowed to contribute the same amount to a Traditional vs Roth. You are. So yes, you can have a scenario in which you have $10k in either a Traditional or a Roth. They just come with different tax consequences, which means if you choose Roth, you have $4k less to contribute to a brokerage account than you would had you chosen to contribute to a Traditional.
We agree you have to pay more in taxes upfront to contribute to a Roth. The total numbers add up in both scenarios … I’m just pointing out that the extra $4k you have by contributing to a Traditional is itself going to live in a brokerage account, not the Traditional account.
Sure, or you could invest in lottery tickets or use $1,000 bills to feed your wood stove and heat your home or volunteer for a one-way manned trip to Mars. There’s a million random things you COULD do.
This thread is about making comparisons to Roth and Traditional. It’s right in the heading. From the perspective of “which is better” it’s important to keep the comparison apples to apples or state up front why it’s appropriate to not do that (“I want to contribute more than the maximum allowable contribution”, as an example).
If you require $X to live on now, and you’re trying to figure out what to do to save for retirement then you’d want to keep your net non-retirement money constant.
Traditional: pay tax later
Roth: pay tax now
Traditional: Set aside $10,000 of pre-tax money. It doubles to $20,000. Pay taxes on the distribution. You’re left with 20000*(1-0.4) = $12,000.
Roth: Set aside $10,000 of pre-tax money. You have to pay taxes so you’re only left with 10000*(1-0.4) = $6,000. It doubles to $12,000, which you can withdraw tax-free.
Either way, for an identical investment, tax rate, and rate of return, you end up with an identical withdrawal.
The things that are driving this discussion are why those conditions might not hold. If you are constricted by maximum contribution rules, if your tax rate changes, if you’re forced to withdraw the money before you actually want it.
Not mentioned is that in theory the higher dollar amount going into the Trad account might have a slightly better rate of return if you, say, qualified for Vanguard’s Admiral shares vs their regular shares which have slightly higher fees. (There’s a minimum investment for Admiral shares.) Most actuaries are going to qualify for the lower fee products anyway, but it’s a theoretical source of difference between the two.
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You’re simply making different assumptions than I am. I am coming at this from the perspective of maximizing retirement account contributions, so I firmly disagree that it’s apples-to-apples to compare $10k of Traditional contributions to $6k in Roth.