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Home » 401K, IRA's, Retirement Planning, Roth 401K, Roth IRA

Roth vs. Traditional Retirement Accounts: Why Roths are Not Always the Clear Winner

Last updated by on 53 Comments

Amongst Gen X and Gen Y, there now seems to be an overwhelming belief that Roths are the better alternative when compared to Traditional retirement accounts.

When I talk to the fine folks I work with and on this blog about why they choose a Roth 401K or Roth IRA versus their Traditional counterparts, the response is something like this,

“Roths allow earnings to accrue tax free, I’ll comparatively save more money for retirement, and I won’t pay taxes on withdrawals in retirement.”

Each of those assertions is true – and I think that is why Roths have rapidly risen in popularity and usage percentage.

But one thing those facts typically overlook is a very important individual variable: your actual income and tax bracket now vs. your expected income and tax bracket in retirement.

Why Tax Brackets are Key in the Roth vs. Traditional Retirement Account Debate

Roth vs Traditional Retirement AccountsRemember that Roth 401K and Roth IRA contributions are post tax – meaning that your contributions are taxed in the year that you make them (vs. tax free until withdrawal for Traditional 401K and IRA contributions).

My guess is that most readers of this blog max out in either the 25% or 28% tax bracket. They are as follows:

  • 25% bracket: single income of $36,900-$89,350, or married income of $73,800-$148,850
  • 28% bracket: single income of $89,350-$186,350, or married income of $148,850-$226,850

As the U.S. tax brackets are progressively laddered, you pay the tax rate on income that falls into that bracket.

The result is that many of us are paying an effective tax rate on Roth 401K or Roth IRA contributions of 28% on the portion of our income over the 28% ladder. At the lowest, many of us would be paying 25% on those contributions.

That’s a pretty high rate the IRS is locking in. And in order for the Roth to be a better alternative, you have to be fairly optimistic that you’ll fall in to higher tax brackets in retirement.

That probably will not be the case for most. Consider that:

  1. Pensions are somewhere between critically endangered to extinct, so very few of us will ever receive a dollar of pension payouts to boost our retirement income.
  2. Social Security is meant to be a supplement, not a primary source of income, and its future ability to pay out in full has been threatened.
  3. 75% of those nearing retirement (age 50-64), have less than $30,000 in their retirement accounts to begin with. $30,000 or less isn’t exactly going to be pushing anyone into higher tax brackets.
  4. The retirement deficit between what Americans have actually saved for retirement and what they should have saved for retirement is already $6.6 trillion. That’s $6.6 trillion of future income that isn’t there to be taxed.
  5. Even after the fiscal cliff deal tax increase on those earning over $400,000, the trend of tax rates has been downward. When looked at historically, tax rates are near the lowest they’ve been since 1931. It seems unlikely that tax rates would go significantly higher from here given the political climate.

Opting for a Roth goes in the face of all of that.

A Reality Check

In order to make more income in retirement than you are making today (to push you in to higher tax brackets), think of what has to happen:

  • You have to consistently save at high enough percentages to be able to fully replace your income, and then some, which requires you to save at significant levels right from the beginning and for many years.
  • You’ll have to significantly outplace inflation on your earnings, achieving something close to historical market returns.
  • You’ll have to not withdraw funds early.
  • You’ll have to stay 100% invested most of the way to reap those returns.

In light of all of that, when you consider that the tax paid now for Roth contributions is a guaranteed rate (for most of us at 25% or 28%) vs. uncertain future tax rates, it should really make you question whether Roths are the smarter option for you.

As Roth 401K’s and IRA’s were approved and joined the retirement account party after their Traditional relatives, perhaps the IRS crunched the #’s and realized that they’d be making more tax revenue off of the population, as a whole, with Roths. If the IRS is good at anything, it’s crunching numbers. Why else would they give us the option to avoid paying future taxes?

I’m not saying that Roths don’t make a lot of sense for a lot of people. I personally maintain a Roth IRA and for those who consistently save at very high levels for retirement and invest it wisely, Roths can be a tax-safe haven in retirement.

There’s no reason you can’t do both, either.

However, before you go all in with Roths vs Traditional retirement accounts, you should give your present and future income, tax rates, and goals some serious thought.

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53 Comments »
  • Chris Smith says:

    G.E., excellent article, everything in it is solid. But (you knew there was a but!) most “Roth vs. Traditional” explanations leave out a very key point, and this one does too.

    Is it a matter of comparing current vs. projected future tax rates? It is if, AND ONLY IF, the tax savings in the traditional account are reinvested. And – most people don’t do that!

    Example: you’re single, and make $50K. You put $10K into a traditional 401k (bravo!). This generates a $2500 reduction in your federal taxes. THE KEY ISSUE IS: what do you do with that $2500? If you reinvest it all back into the 401k, on top of the $10K – then, and only then, can we proceed with the familiar tax rate comparison. But if you don’t, you’ve defeated the main advantage of these accounts over Roths.

    If it comes to you as a refund, it’s tempting to let “windfall logic” take over, and just spend at least part of it. And if it doesn’t – if it’s offset by other unrelated tax liabilities, or if you changed your withholding in anticipation of the reduction – then it’s even HARDER to convince yourself to reinvest it.

    That’s why I usually recommend Roths to people in their 20s and 30s. Unless you’re in an unusually high bracket in your early financial life – or you have an unusually high financial IQ and discipline to match – the “pay as you go” Roth will end up helping more people.

    • G.E. Miller says:

      Good point. I guess it shouldn’t be assumed that just because it’s a retirement account, people are investing in it.
      It’s a retirement account, invest, people! (and re-invest dividends/cap gains).
      There…. said it.

      • John says:

        I think a large consideration missed here is time. If you’re truly talking to 20/30 something’s then doesn’t a 30+ year timeframe for compounding mathematically make the Roth superior? Also, regarding taxes I find it bold to take the position that in “this political climate” taxes won’t be higher. Who can say either way if we’re talking 30 years from now? History would say they’ll be higher. And finally, I think you should consider another reason the IRS may support Roths. We’re in a cycle where current liabilities are calling and the strategy seems to be to kick the can out as far as possible. Numbers aside, the Roth gets the tax money in the system now and the Traditional defers it to later. Seeing as the viewpoint appears to be focused on what’s right in front of us, I wouldn’t discount this as the real, or at least major reason. Not that it simply gets them more tax revenue overall.

        • Branden says:

          One of the largest fallacies related to Roth (which was not discussed) is the concept that putting in after tax dollars now that grow tax free will earn you more than if you saved in a traditional deductible. For comparisons sake, assuming your tax rate is the same now and when you retire, G is your gross income and T is your tax rate and your investments grow by a factor of 10 before you retire:

          Traditional = G * 10 * (1-T)
          Roth = G * (1 – T) * 10

          Both equations are identical. You end up with the same amount both ways. Compounding plays no role here. The real issue (which was discussed in the article) is what is you tax rate now, and what will it be when you retire. There are a few other advantages to Roth (reducing risk of increasing tax rates, tax diversification, not subject to 70 1/2 required distributions, etc.) But, point still being, you’re missing the boat.

          • Ben says:

            While both equations are identical, the biggest assumption here is that taxes remain the same. I am sure 20 years ago, people would have laughed at the thought of the ACA surtax. There is a reason why affluent individuals are converting… If I made 30 grand a year and could only save a little, I wouldn’t save my money in a 401k at my employer to get the “tax” savings (except for the employer match)… because it is much more likely that I will be withdrawing more than my current 30k (equivalent) salary 20-30 years in the future. There are a lot of “what if” scenarios that support contributions to a roth.

          • Branden says:

            Sorry couldn’t respond directly to your response Ben, not sure why.

            The example I gave was not suggesting that your tax rates will be the same regardless, it was to illustrate that a Roth IRA is not ‘tax free’ earnings the way most people assume it is.

            If you’re only make 30k, that throws you in the 15% bracket. It probably would make sense to use a Roth rather than a traditional.

            Who are these affluent individuals converting? There are many situations in which converting would be advantageous. If you are in lower tax bracket than usual (for example when you retire, or if you’re laid off), then its a good time to convert if it mathematically makes sense in your personal situation.

    • John says:

      Chris, this really depends on how you look at the tax break. I have always thought of the tax break as a government match similar to a company match. Given your example, I would view it as contributing $7500 and that the government is giving me a $2500 match.

      This is especially true for people who have already been contributing to a traditional 401k. Using your example, I am currently contributing $10K to my 40lk, but I decide to split it up and put $5K in my 401k and put $5k in a Roth. However, reducing my 401k contribution by $5k will only result in a yearly increase in take home pay of $3750. If I still want to put $5k into a Roth, I need to come up with the remaining $1250 myself.

      That is not to say that I think a Roth account is a bad idea. Roth IRAs have a few advantage over other retirement accounts (including Roth 401ks) that may them a compelling option. There are no minimum distribution requirements for Roth IRAs. You can also withdrawal your contributions at any time without penalty.

  • garrett says:

    i always like the finance buff’s article on this topic.

    http://thefinancebuff.com/case-against-roth-401k.html

    also remember that once retired, you can convert traditional to roth, only enough to fill up the lowest tax bracket(s). tax free in, tax free out.

    • Drake says:

      this is false. you will still end up paying taxes for converting – my dad just converted his traditional ira to a roth and owed a hefty amount in taxes when he filed his return.

      • garrett says:

        it is not false. conversions are considered income and taxed at your marginal tax rate. so if your dad had more income than the standard deduction + exemption, of course he paid tax on it. the goal is to only convert enough each year before breaking into the next tax bracket.

        i sure hope he didnt convert and pay more in taxes on the conversion than he originally saved on his contributions

  • Sam says:

    The advice I got was that you want a portfolio so you can minimize taxes later on.
    Don’t forget about fees, though. My company plan has no match, and the fees add up to 1.5% or more for every fund choice because the 401k company takes a cut on top of the fund. This makes my self directed Roth with average fees of .15% the clear winner even with tax rate differences.

  • Sam says:

    what I meant was tax portfolio, i.e. a mix of both types of account

  • Mary says:

    I do both to diversify. Chris makes a great point about investing the savings. It seems like most people don’t think about that at all when making the comparison.

  • Jake Erickson says:

    This is an awesome overview. So many people just think that not paying taxes when you take it out is so much better, but that isn’t always the case. I’ve been thinking about this quite a bit lately and I think I’ve decided to do some of each just to make sure I’m diversified.

  • Warren says:

    There’s another point to the Roth IRA. When you put the maximum into a regular IRA, because the tax is deferred, part of that money will eventually have to go to taxes. So you can think of the money as being two sub groups, your benefit and the deferred taxes. So this year the max IRS is $5,500 so maxing your IRA means that a larger part of $5,500 (But still less than $5,500) is what you are putting towards your retirement and a smaller part of $5,500 is what you are putting away to cover the taxes that you are not paying now. On the other hand, maxing a Roth IRA means that you are putting a full $5,500 towards your future retirement.

    • Chris Smith says:

      Great point, Warren. In a very real sense, Roths effectively have higher contribution limits than their traditional counterparts, for exactly the reason you explained. People who are maxing out traditionals, and would contribute more if they could, should keep this in mind before even getting to current vs. expected future tax rate comparison.

      • Yea, but to put $5500 into the Roth IRA you would have had to have $7k if you were in the 28% bracket since you are paying the tax upfront. I guess it depends really on if you have the extra cash to pay the tax upfront for the Roth.

        • Warren says:

          That’s the thing. It’s the people with the resources to max out the contribution that this applies to. If someone is putting money into a non-tax advantaged account because they have hit the contribution limits, they are paying the tax on income up front anyway.

  • jim says:

    K – generation “old guy” here. Now I am totally confused. I had just convinced myself to roll our traditional ira’s over to roth’s and now you’ve got me confused. Spouse and I are going to retire in 10 years. We’ve got $700,000 in traditional ira’s and are in a 28% tax bracket. Should we roll them into roth’s? If so, what’s our tax bill going to be for simply rolling them over. Any and all input would be greatly appreciated. I swear every time I think I finally understand some of this crap I end up more confused than ever.

  • Jon Maroni says:

    G.E,

    This is the first time I have ever heard someone intelligently challenge the notion of Roth IRA superiority. I have already begun my retirement savings, primarily with a 401k and Roth IRA. I’m able to contribute to them regularly, do you think it might be wise to switch to a traditional IRA? I can’t honestly say that I’m certain we will get beyond the 25% tax bracket. What do you think?

  • Kevin says:

    Growth is the real important factor, assuming that the saver is good about putting away money. $5,500 a year for 40 years is $220,000. If I triple my money in 40 years, I will have saved taxes through the years on $220,000, but will have to pay taxes on $660,000, as I take out the money.

    If I do the Roth, I will pay taxes on the $220,000 through the years in dribs and drabs, but I will have gained $440,000 that I don’t have to pay taxes on.

    Using a Roth, my retirement tax rate is 0.

    A traditional IRA should only be used by people who absolutely need the tax break now; people should switch to Roth as soon as they can afford it.

    • Jon Maroni says:

      Kevin, in my instance we are good at putting money consistently into our Roth IRA. I would much rather be taxed on the lower amount in the scenario you laid out. So is it safe to say that if you are a consistent saver (maxing out your contributions each year) who starts early that a Roth IRA is the best choice? All the reading I have done would indicate yes. That seems to be what I hear you saying.

      • Kevin says:

        When I did my first IRAs, I don’t believe the Roth was an option, so I had gone traditional. One of the funds I invested in has done phenomenally – $4,000 initial investment 20 years (less than that, but I can’t recall the exact year) is worth $27,000. I got the tax break on the $4K, but when I take the money out, the whole $50K (projection based on past growth, which may or may not happen) gets taxed. Again – it wasn’t an option at the time, but if it was, I’d rather have paid the taxes on the $4K rather than the $50K.

        The next couple of IRA investments were Roth. All this time I’ve maxed out on my 401K. Again, when I started, a Roth wasn’t an option, so it was traditional. Now of course I put a LOT more money into the 401K and since buying my house I haven’t kept up with the IRA, but I can always add to those later. The tax on $15K is a bit more than the tax on $5K, so every 6 months I’d change my mix of traditional and Roth 401K by 2% – I’m still maxing out, but by not doing a full switch, I feel the pinch to my take-home pay a little less.

        I’ve got about $380K in the 401K combined. Last year it grew by $60K; it’s already up $60K this year. A good chunk of this is traditional and I’ll be taxed on it, but each year, more of the growth will be on the Roth side – I’m being taxed now on $15K (or whatever the limit is), but I’ll be building $60K of tax-free growth (and even that will increase) each year until retirement.

        Growth is the main thing you’re looking at with retirement funds. The tax rate is a minimal concern.

  • Natalie H says:

    You missed one important point. You aren’t taxing the same amount you put in as you take out. If your growth is 2% more than inflation then in 35 years your money will double in real dollars. So if you have a traditional, you will be taxing twice as much money. Therefore, if you are in your 20s and planning a traditional retirement age, you may want to consider if your tax rate is likely to be less than half of what you are currently paying, not just lower.

  • Anton Ivanov says:

    You have a point, except the way you look at the tax percentage that you pay on your Roth contributions. Since the tax bracket system is progressively loaded, like you pointed out, the average tax paid will be much lower than the 25/28%. My guess it is probably less than 15%.

    The rest of the article makes sense – you still have to make an educated guess whether or not your retirement effective tax rate is going to be higher or lower before deciding on a Roth vs traditional retirement account.

    • Mike says:

      The contributions to Roth 401k/IRA or any conversions are taxed at your marginal rate. If that marginal rate spans a couple of brackets then you can average it out. It is not taxed at your effective rate in all but extreme cases. Withdrawals of pretax IRA/401k money will be at the effective rate.

  • Steve says:

    I feel you make a good point about those in the 28% bracket, but if you’re in the 25% bracket, wouldn’t the Roth IRA be superior? If you’re currently in the 25% bracket, I don’t think it’s a stretch to suggest that you’ll probably be in the 28% bracket eventually. Today’s recent college grad earning $40-$50K in an entry-level job may be tomorrow’s mid-level manager earning $95K, and that 3% savings from a Roth can be huge.

    I must disagree about the argument tax rates won’t increase due to politics. In *today’s* political climate, sure. But if you look at the demographics and trends, it looks like Democrats will win more and more elections if nothing changes. In all likelihood, the Republicans will see this coming and go more towards the left, and to differentiate themselves, the Democrats will go even further left. In that environment, assuming we still have our large deficit, tax increases will become much more likely since it’s what Democrats tend to propose to help balance the budget.

  • Warren says:

    In 1974, then the IRA was started, the highest tax bracket was 70%. With a traditional IRA, you might consider that you are waiting until the future to get your pay. When you get your pay is when you get taxed. At that tax rate, even without consideration of the benefits of compounding with deferred tax, simply delaying the tax until your income was lower at retirement was in itself significant reason to put money in an IRA. Now that taxes are historically low, the benefit has shifted much more towards the compounding. Of course the rule of trying to be in a lower tax bracket still exists, it just has less of an impact on the total.

    Remember that the money you have in a Roth IRA can be taken out on a more flexible schedule than the money in traditional IRA. After all, you have already paid the taxes on the Roth IRA so the IRS doesn’t create such stern rules. There is nothing that says that you have to take your money out of the Roth IRA when you start your retirement.

    Think of this, assuming that when you get to 56 years old, you are ten years away from using some of the retirement money at age 66. On the other hand you are 30 years away from using the retirement money at age 86. Several people I know have suggested that the money in the Roth IRA is the last money that they will use since that money has effectively the highest after tax rate of return. This is where they have their emergency fund and the money to cover inflation if it becomes a problem.

    • Jon Maroni says:

      I hear what you are saying Warren, except what the post is contending is that many people talk about putting away gobs for retirement but few actually do it. The final scenario you lay out (where a Roth IRA is the last money an individual will use in retirement) doesn’t seem to reflect the reality of what most people will face in retirement. I think that for most people their Roth IRA will be their only retirement account. As G.E. pointed out most people haven’t saved nearly what they need to retire.

      • John says:

        Come on now. Roth will be all people have? If you’ve got a Roth you more than likely are saving through a work retirement plan as well. So in effect, you’ll have a traditional IRA from that when you retire, making that their primary account and Roth secondary.

        • Jon Maroni says:

          I don’t think that my statement is inaccurate, I know that whenever I change employment the first thing I’m going to do is roll over my 401k into a Roth IRA. In fact I would be crazy not to because of the tax advantages, so yes I think that the Roth IRA is going to be the main investment vehicle that most people use.

          • John says:

            So you’re going to rollover your 401k accounts as you leave jobs into Roths? So you’re going to do a conversion and pay the tax bill right then each time? Even if you say yes, you will be the far minority as almost all will either leave the 401k where it is (dumb) or roll it over into a traditional IRA to maintain the same tax status. So, still, traditional IRA ends up as primary retirement account for the vast majority.

          • Warren says:

            Unless you are changing jobs often, your rollover strategy suggests that you might be defeating one of the major advantages of the IRA. Putting several years of IRA accumulation into a Roth IRA all at once sounds like a way to work yourself into a higher tax bracket.

  • JoeTaxpayer says:

    I’ll add one caution. The phantom tax rate. In 2012, a single retiree would see an IRA withdrawal of $25K push her into the 27.5% marginal rate. I know, there is no 27.5% bracket, and $25K after the standard deduction and exemption is a comfortable 15%. But. The impact of how Social Security is taxed create this effective rate and a 46.25% rate beyond that. The next $1000 withdrawn causing your tax bill to go up $275 or $462.
    Even though the Social Security taxation hasn’t been adjusted in a long time, the normal brackets and other factors do adjust. So, in today’s dollars, it’s a pretax $625K or so that’s the limit for a single retiree.

    For your analysis, a retiree with Roth money but much less than this $625K has left money on the table and should have stuck with pretax deposits. The topic can fill a huge book, as any single article is going to attract a list of ‘but you missed’ comments. Good start.

    • Jon Maroni says:

      I guess I have a great deal to learn about this. I’m at the beginning of my working career and haven’t ever been through the rollover process. Is it most advantageous to roll into a Roth? That’s what I had assumed was the right move, what considerations do you have to take into account?

      • John says:

        Most common procedure is to rollover to a traditional IRA because nothing really changes with the account from a tax perspective. You certainly can do a conversion of the 401k to a Roth, but the IRS will come knocking for the tax that you avoided by contributing pretax to the 401k. Really, there is no absolute answer in those situations as each person’s tax situation is unique. Because its such a big decision if someone wants to go the conversion route it’s well worth the time to visit with a CPA, CFP, or advisor to make sure everything is covered and you don’t do something that isn’t best for your situation.

      • JoeTaxpayer says:

        Jon – it’s tough to generalize, but a good start is to put 15% money in the Roth, and as you get to the 25% bracket, to shift to pre-tax.

        I always suggest the 401(k) from prior job get moved to a regular IRA and convert to Roth at your convenience, only if it makes sense.

  • Mike says:

    One of the biggest decision variables is mentioned rarely if at all in most discussions. It is not your current tax bracket vs future tax bracket. Rather it is your current marginal bracket vs your future effective tax rate. Great discussion of this on the Bogle Heads site at Vanguard.

    Odds of your future effective tax rate being higher than your current marginal rate are minimal for the vast majority of people.

    Like smoking cigarettes, tanning and energy drinks many people will look back in 20 years and wonder what they were thinking when they made the Roth conversion.

    • JoeTaxpayer says:

      Mike – It’s a tough concept for most to grasp. You are close to how I describe it to people.

      I agree 100% that deposits are at the current marginal rate.

      Withdrawals span multiple rates. You first have the Zero Bracket (my term for the sum of your exemption and standard deductions), then a 10% rate, 15% etc. If you are in the 25% bracket today, you benefit from filling those first brackets at retirement. And it would then take a taxable $72K at retirement to have any money taxed at 25% which is really break-even, not a loss.

      The issue I warn against is the phantom rate that comes with social security taxation. That’s worse thsn just the marginal rate you might hit and occurs at far lower income levels (than the 25% we try to avoid).

      • Mike says:

        Joe- Yes the social security taxation is an issue. However, I have more confidence that SS will become and increasingly smaller piece of retirement income than 401k savings will. For those at or near retirement today then it should be a consideration when looking at Roth Conversion.

        The best thing about Roth monies is the ability to have some control of tax brackets for one time expenses. It is an account to draw from and when large one-time expenses come into play (roof, big trip to Europe, Weddings).

        Much of the Roth mania and conversion talk is being driven by political leanings….which history has generally shown to be foolhardy!

        Buying gold in a converted Roth account won’t change who is in office. But might well send a retired person back to an office job.

  • Shaun says:

    I find it incredibly shortsighted to merely look at the benefits of a Roth IRA vs a Traditional IRA as to your life costs. How about considering the impact of the individual who will obtain this account after your death?

    Roth IRA accounts are not taxed on the amount of gains after death either (ie the person withdrawing the gains). So if the balance fell into the lap of your grandchild and they delay withdrawing them as long as they can, this increases the benefits of compound interest and growth to grow tax free!!

    If you have any accounts in a traditional IRA that you expect to give to a younger beneficiary (or a generation skipping trust) then it would be wise to make transfers when the account is low (market dips…can buy back at low in the roth), and when the tax rates are low, and you have enough to afford the tax.

    • JoeTaxpayer says:

      It’s still the tax bracket that matters.
      If my mom pays 25% now, the account is smaller, and the withdrawal my daughter could make at 0-10% is lost. It’s only when the retiree is in a lower bracket, say 15% vs the beneficiary working still, at 25% that what you suggest is the better option.

      Disclosure – my MIL is converting each year, on my advice, only to top off her 15% bracket. This saves her from being pushed into the 25% bracket with RMDs, and will leave the Roths for her daughters who are in the 25% bracket. An example of when your advice is perfect.

      • Shaun says:

        My point is less that of the tax brackets (and tax burden on decendents), but more on the taxation of what is grown.

        In the case of a Roth IRA you have paid taxes on the contributions. Lets say a baby does a diaper ad and we can have the check written to my child for $10,000. I put the max in to a Roth IRA account (lets even pretend she is in the 25% tax brackets).

        When she turns 60, so 59 years at 10% return (stock market avegages a bit higher, but for example sake), her $5,500 will turn into over 1.5 million dollars… so would I like to pay 25% tax on $5,500, or would I like to pay 25% on 1.5 million dollars? The untaxable compounded growth makes Roth’s the hands down winner if you plan to invest lots, consistently, over a long period of time, and have a large chunk to grow further for those who will be making TAX-FREE withdrawals after your death.

        It boils down to how long this fund with have compounded growth. But there are LOTS of other considerations to make concerning the costs now and the cost when you retire and the costs to those you love dearly.

        • JoeTaxpayer says:

          You have $1000, pay $250 tax and invest $750 in Roth. 10X the return later you have $7500.

          I save my $1000 pretax, grow it the same 10X to $10000 and pay 25% at withdrawal, and have $7500.

          Time doesn’t matter, it’s the differential in marginal rates on deposit and withdrawal. It’s not really intuitive as many advisors mistakenly talk about the long term benefit of tax free compounding. So long at the taxed withdrawals don’t throw you into a higher bracket, of course.

          • Mike says:

            Joe,

            I agree that you have the variables described correctly. Once you strip away all the language and stick to the numbers the truth is revealed. I have no pro Roth or anti Roth agenda, but rather believe that many people are making the decision to convert based on faulty logic and premises.

            The financial industry often exerts this type of mental jujitsu on the public. Since many people are all riled up along party lines and it is easy to get them to make emotional decisions….why not use the fear of higher taxes in the future to encourage them to discuss their portfolio under the premise of tax avoidance.

            Mike

          • Shaun says:

            Lets pretend that we are maxing our account out.

            If we are investing $5,500 to max out either account:

            Traditional IRA: $5,500 * 25% is $1,375 in tax savings. And lets say for optimum sake they reinvest it (in a taxable account obviously), and that grows to $13,750 and the $5,500 grew to $55,000. Tax expense at the end of 10x. 25% of $55,000 and 25% of 12,375 (total investment minus basis) is a total tax bill of $16,843.75. Total Cash at end is $68,750, less total tax at the end equals $51,906.25.

            Roth IRA: $5,500 * 25% is $1,375 tax paid now. $5,500 10x is $55,000.
            $55,000 year 10 – $1,375 from taxes year 1 = $53,625.

            You would be ahead in a Roth if you were investing the same IRA base into the account. Even if you wisely invested the tax savings, which few people do. The taxes don’t come from the investment base and most people think: “Oh I’m contributing X% to my retirements.” Not “oh i’m investing $1000, and since it’s a Roth I better only invest $750 and save the rest for taxes”, the taxes already are taken from their checks in most cases.

            Then at the end you aren’t struggling to play the tax bracket game and worrying about tax burdens on withdrawals when you are 85 and have dementia. Or have emergencies and need to bleed your account for $100K.

            There are instances where a traditional would make sense, but anyone who is a working 20 something, it’s likely they would be better off with Roth, unless of course you are in a super high tax bracket, but keep in mind we are in historical lows for taxes now and the current deficit and budget problems I see those rates increasing within a decade or two.

            Great discussion though and I love the blog GE!

          • JoeTaxpayer says:

            Shaun – Your answer below ‘double dips.’
            When I assume the $1000 pretax, there no ‘tax refund’ as the $1000 is just that, pretax. There’s an awful lot I don’t know about, or understand. The math of the Roth/IRA is my strong point. Please re-read my example above.

  • Very nice argument for turning the logic of this choice on its head. Remember that this still is guess work because no one knows where rates will be at retirement. One could say rates may go up because of deficit realities, notwithstanding current politic winds. But your points are well taken.

    • Mike says:

      Steven,

      Joe is simply doing the math. Not really any argument involved as he is not Pro Roth or Anti Roth. While future tax rates etc are something we cannot predict we can understand the basic math involved and that will get us closer to making the best decision. The points made in these comments show that many people are not making the decision based on an understanding of the math as it relates to taxation of the two accounts.

      With many people it seems they are so focused on the increasing tax scenario that they are not wanting to believe the Roth is not always the superior account. The irony in this is that many are making decisions that will turn out to be exactly the opposite of what they set out to do, pay less taxes.

  • Warren says:

    There are factors other than just doing math. First off is the psychological less money in your pocket to spend factor resulting from putting money into a Roth IRA. There is also the idea that some people want their retirements to be less complicated. Not having to deal with taxes on their retirement funds might bee seen as beneficial. If someone puts less into a Roth IRA, but equivalent to the after tax value of what they would have put in a regular IRA, they will constantly see a lower balance in a Roth IRA and might be inspired to save more. Having a retirement account where the money is withdrawn based on how best to serve the retirement is a lot more appealing than having a retirement account where the money is withdrawn based on the tax structure.

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