Roth vs Traditional 401K for Single $75K-$90K income?

[sdt1890]

Making my way through the JL Collins series, but wanted to ask about this. I keep coming across the Investment Order thread here - https://forum.mrmoneymustache.com/investor-alley/investment-order/msg1333153/#msg1333153 that states 4. Rule of thumb: traditional if current federal marginal rate is 25%; Roth if 10% or lower, or if MAGI is too high to deduct a traditional IRA; flip a coin otherwise. 

I'm late 20s, no debt, and likely will be married in the next few years at most. I've been choosing the Roth 401K option, but second guessing that now that my income has grown. Opinions would be great to hear on this topic. Thanks!

[Paul der Krake]

At your income level, pre-tax is absolutely the way to go.

[MDM]

Making my way through the JL Collins series, but wanted to ask about this. I keep coming across the Investment Order thread here - https://forum.mrmoneymustache.com/investor-alley/investment-order/msg1333153/#msg1333153 that states 4. Rule of thumb: traditional if current federal marginal rate is 25%; Roth if 10% or lower, or if MAGI is too high to deduct a traditional IRA; flip a coin otherwise. 

I'm late 20s, no debt, and likely will be married in the next few years at most. I've been choosing the Roth 401K option, but second guessing that now that my income has grown. Opinions would be great to hear on this topic. Thanks!

Where do you fall in the rule of thumb spectrum?

If you want to go into more detail than that rule of thumb:
1) What marginal rates do you go through for $0 - $18K in 2017 401k contributions?  See the case study spreadsheet.  The template uses 401k contributions by default for the chart over 'Calculations'!I75.  See 'Instructions'!B15 and following if you want to change that.
2) What is your best guess at marginal rates in retirement?  See the investment order post you mentioned for a process to make this guess.

[sdt1890]

At your income level, pre-tax is absolutely the way to go.

Could you provide further details?

[Paul der Krake]

At your income level, pre-tax is absolutely the way to go.

Could you provide further details?

In broad general terms, paying taxes later is better than paying now.

However, in a low tax bracket the difference isn't quite as stark, and there is value in putting money in a Roth. This is why people do Roth ladders in their low-income years of early retirement.

[czr]

Right now you are in the 25% tax bracket so you are paying that % in taxes on all the income you make over $37,950. When you retire you will most likely make less than your working years income so you should be taxed at a lower tax rate. If you think you will be in a higher tax bracket when you’re retired than 25% (studies say you’ll make less) then take the ROTH option now. There are also tax credits and deductions available (student loan interest deduction, child tax credit, etc.) now which are not available when you’re retired.

[GizmoTX]

At $70-90k income, you are better off choosing the traditional 401k which will lower your gross income & federal taxes. You can also contribute to a Roth IRA. If your income keeps increasing, eventually you will not be able to contribute to a Roth, so grab it now, after the traditional 401K.

[SeattleCPA]

Agree with all of the posters' comments above.

To add one hopefully helpful comment: You want to avoid paying taxes at the highest rate.... so if today you're paying 25% (which is actually pretty high) and at some future date in retirement you'll be paying 15%... you want to pay more 15% and pay less 25%.

The way you'd do this is by using traditional IRA or 401(k) today... thereby saving 25%... and then withdrawing money in future... and then paying 15% say.

Another point: It's easy to way overestimate your retirement years' tax rate.

[LawyertilRetire]

I'd echo the posters here in saying that a Traditional 401k may be your better option but don't beat yourself up though over your past Roth contributions. You will be happy to have a pool non-taxable funds to withdraw from in retirement.

One exception would be that if you are maxing out your 401k in Roth contributions, you may want to continue to do so -- 18k post-tax is more than 18k pre-tax when you withdraw it.

And, if you have the funds, I would consider opening a Roth IRA for additional tax protection.

[JLee]

I'd echo the posters here in saying that a Traditional 401k may be your better option but don't beat yourself up though over your past Roth contributions. You will be happy to have a pool non-taxable funds to withdraw from in retirement.

One exception would be that if you are maxing out your 401k in Roth contributions, you may want to continue to do so -- 18k post-tax is more than 18k pre-tax when you withdraw it.

And, if you have the funds, I would consider opening a Roth IRA for additional tax protection.

I would absolutely not do that. Changing your taxes from your current last dollar earned to your future first dollar earned is of dramatic benefit. See: http://www.gocurrycracker.com/roth-sucks/

The choice is basically 18k post tax *or* 18k pre tax plus what, $4k (what you would have paid in taxes on that $18k) to allocate elsewhere - either $4k to a tIRA or ~$3k to a Roth or taxable fund (in this case Roth due to income limits, and even that will go away if the OP's income continues to scale).

[LawyertilRetire]

The math on the traditional 401k resulting in a better outcome only works if the would-be taxes are invested, all else being equal. But that is a good option.

Depending on the MAGI, a Traditional IRA may not be available and a Roth IRA may be the only IRA option that makes sense. Even after exceeding the Roth's income limits if income continues to rise, backdooring a Roth IRA would be an option that makes sense for supplemental retirement savings.

[MDM]

One exception would be that if you are maxing out your 401k in Roth contributions, you may want to continue to do so -- 18k post-tax is more than 18k pre-tax when you withdraw it.

I would absolutely not do that. Changing your taxes from your current last dollar earned to your future first dollar earned is of dramatic benefit.

Both these statements are false (or at least not completely true), although they do recur from time to time in this forum. Bogleheads, etc.

The starting point for any traditional vs. Roth choice should be the commutative property of multiplication:
    Traditional = Original_amount * Growth * (1 - withdrawal_tax_rate)
    Roth = Original_amount * (1 - contribution_tax_rate) * Growth
For equal tax rates, the results are identical.

Now, there is a wrinkle that may cause Roth to be preferable for identical rates or even withdrawal rates slightly lower than at contribution.  See Maxing out your retirement accounts.  E.g., it's plausible that Roth could be better than traditional if contributing at 28% tax saving and withdrawing at 25% taxation.  When it is 25% contribution and 15% withdrawal, however, traditional will be better.

Traditional will not, however, be as good as a "current last dollar earned to your future first dollar earned" comparison indicates.  For one to make a correct decision, the comparison really does have to use marginal tax rates for both contribution and withdrawal.  The GCC article is simply incorrect on this point.

[MDM]

The math on the traditional 401k resulting in a better outcome only works if the would-be taxes are invested, all else being equal.

Not sure to what math you refer - could you elaborate?

[JLee]

One exception would be that if you are maxing out your 401k in Roth contributions, you may want to continue to do so -- 18k post-tax is more than 18k pre-tax when you withdraw it.

I would absolutely not do that. Changing your taxes from your current last dollar earned to your future first dollar earned is of dramatic benefit.

Both these statements are false (or at least not completely true), although they do recur from time to time in this forum. Bogleheads, etc.

The starting point for any traditional vs. Roth choice should be the commutative property of multiplication:
    Traditional = Original_amount * Growth * (1 - withdrawal_tax_rate)
    Roth = Original_amount * (1 - contribution_tax_rate) * Growth
For equal tax rates, the results are identical.

Now, there is a wrinkle that may cause Roth to be preferable for identical rates or even withdrawal rates slightly lower than at contribution.  See Maxing out your retirement accounts.  E.g., it's plausible that Roth could be better than traditional if contributing at 28% tax saving and withdrawing at 25% taxation.  When it is 25% contribution and 15% withdrawal, however, traditional will be better.

Traditional will not, however, be as good as a "current last dollar earned to your future first dollar earned" comparison indicates.  For one to make a correct decision, the comparison really does have to use marginal tax rates for both contribution and withdrawal.  The GCC article is simply incorrect on this point.

We're on a forum for early retirement.  Equal tax rates implies equal income.  Equal income implies you're retiring on what you currently earn.  That's something that almost nobody here is planning, as far as I know.

When you're retired and not working, drawing down from a Traditional 401k is taxable income.  You start at zero and go up from there. When you are working, 401k contributions come off your highest marginal rate, i.e. last dollar earned.  How is this incorrect?

Now, if you plan on spending more in retirement than you earn while working (or have a ridiculous pension plan providing you a firehose of retirement cash), sure - Roth it up. I think that means you worked too long...

[JLee]

The math on the traditional 401k resulting in a better outcome only works if the would-be taxes are invested, all else being equal.

Not sure to what math you refer - could you elaborate?

$22k = $18k after tax = $18k Roth contribution

vs

$22k = $18k pre-tax Traditional contribution = $4k remaining = $3240 remaining for post-tax investments

vs

$22k = $18k pre-tax Traditional contribution = $4k remaining = $3240 spent on whatever

Of these three options, the 3rd Traditional option loses because the deferred taxes are not used to one's advantage, and the "extra" (deferred cost) is instead spent immediately.

[MDM]

When you're retired and not working, drawing down from a Traditional 401k is taxable income.  You start at zero and go up from there. ...
How is this incorrect?

It's incorrect because not only pensions, SS, etc., but also withdrawals based on previous years' traditional contributions fill those bottom brackets.

E.g., if one has been contributing to traditional accounts for 20 years, the withdrawals based on the 21st year of contributions won't "start at zero" - correct?

[MDM]

The math on the traditional 401k resulting in a better outcome only works if the would-be taxes are invested, all else being equal.

Not sure to what math you refer - could you elaborate?

$22k = $18k after tax = $18k Roth contribution
vs
$22k = $18k pre-tax Traditional contribution = $4k remaining = $3240 remaining for post-tax investments
vs
$22k = $18k pre-tax Traditional contribution = $4k remaining = $3240 spent on whatever

Of these three options, the 3rd Traditional option loses because the deferred taxes are not used to one's advantage, and the "extra" (deferred cost) is instead spent immediately.

If this is what LawyertilRetire meant - or even if it isn't ;) - this is the situation described in Maxing out your retirement accounts.

Yes, for an apples to apples comparison one must start with the same amount of pre-tax money.  That requires a taxable "side account" for the traditional path when the Roth pre-tax amount is greater than (IRS maximum) * (1 - contribution_tax_rate).  For Roth pre-tax amounts less than (IRS maximum) * (1 - contribution_tax_rate), no side account is needed and the commutative property equations apply directly.

E.g., for someone paying a 25% rate, 401k contributions below $13,500 pre-tax can be compared directly with no need for qualification.

[JLee]

When you're retired and not working, drawing down from a Traditional 401k is taxable income.  You start at zero and go up from there. ...
How is this incorrect?

It's incorrect because not only pensions, SS, etc., but also withdrawals based on previous years' traditional contributions fill those bottom brackets.

E.g., if one has been contributing to traditional accounts for 20 years, the withdrawals based on the 21st year of contributions won't "start at zero" - correct?

No idea, actually.  Again, this is a retiring early forum and the thread was posted by someone in their 20's.  I am not thinking they'll be contributing to a traditional retirement plan the year before being eligible to make withdrawals from said plan at 59 1/2 years old. Most people will have a 5 year gap before they can structure a conversion ladder, yes?

If we're talking about retiring at an age where you're eligible to withdraw immediately from a Traditional 401k and you're also receiving social security, I'm out of the discussion. That's not my game, and I'll be the first to admit I don't know shit about it.  :P

[MDM]

When you're retired and not working, drawing down from a Traditional 401k is taxable income.  You start at zero and go up from there. ...
How is this incorrect?

It's incorrect because not only pensions, SS, etc., but also withdrawals based on previous years' traditional contributions fill those bottom brackets.

E.g., if one has been contributing to traditional accounts for 20 years, the withdrawals based on the 21st year of contributions won't "start at zero" - correct?

No idea, actually.

Ok...in that case are you willing to believe the Bogleheads wiki I've used for several of the links on this?

Again, this is a retiring early forum and the thread was posted by someone in their 20's.  I am not thinking they'll be contributing to a traditional retirement plan the year before being eligible to make withdrawals from said plan at 59 1/2 years old. Most people will have a 5 year gap before they can structure a conversion ladder, yes?

And for someone just starting*, traditional is likely the better choice.  But for others reading this (say, those in their 30s, 40s, etc. - or to benefit those 20-somethings in years to come), giving correct advice as generically as practical is worthwhile.  In this case, "when (if ever) to switch from traditional to Roth?" depends (among other things) on how much one has already contributed to traditional accounts.  And the way to evaluate "how much is too much?" is to compare marginal to marginal.

See the full Traditional versus Roth - Bogleheads wiki, and the background (links and footnotes) to item #4 in Investment Order for more details.  Does going through those make this clearer, or is it still muddy?

*Med school grads in residency are a notable exception due to their much higher expected incomes in future years.

If we're talking about retiring at an age where you're eligible to withdraw immediately from a Traditional 401k and you're also receiving social security, I'm out of the discussion. That's not my game, and I'll be the first to admit I don't know shit about it.

Nope, SS is just one of many things that can push traditional withdrawals into higher marginal rates.  We can eliminate SS and pensions from the discussion entirely, and still be left with marginal vs. marginal.

[JLee]

When you're retired and not working, drawing down from a Traditional 401k is taxable income.  You start at zero and go up from there. ...
How is this incorrect?

It's incorrect because not only pensions, SS, etc., but also withdrawals based on previous years' traditional contributions fill those bottom brackets.

E.g., if one has been contributing to traditional accounts for 20 years, the withdrawals based on the 21st year of contributions won't "start at zero" - correct?

No idea, actually.

Ok...in that case are you willing to believe the Bogleheads wiki I've used for several of the links on this?

Again, this is a retiring early forum and the thread was posted by someone in their 20's.  I am not thinking they'll be contributing to a traditional retirement plan the year before being eligible to make withdrawals from said plan at 59 1/2 years old. Most people will have a 5 year gap before they can structure a conversion ladder, yes?

And for someone just starting*, traditional is likely the better choice.  But for others reading this (say, those in their 30s, 40s, etc. - or to benefit those 20-somethings in years to come), giving correct advice as generically as practical is worthwhile.  In this case, "when (if ever) to switch from traditional to Roth?" depends (among other things) on how much one has already contributed to traditional accounts.  And the way to evaluate "how much is too much?" is to compare marginal to marginal.

See the full Traditional versus Roth - Bogleheads wiki, and the background (links and footnotes) to item #4 in Investment Order for more details.  Does going through those make this clearer, or is it still muddy?

*Med school grads in residency are a notable exception due to their much higher expected incomes in future years.

If we're talking about retiring at an age where you're eligible to withdraw immediately from a Traditional 401k and you're also receiving social security, I'm out of the discussion. That's not my game, and I'll be the first to admit I don't know shit about it.

Nope, SS is just one of many things that can push traditional withdrawals into higher marginal rates.  We can eliminate SS and pensions from the discussion entirely, and still be left with marginal vs. marginal.

I have done literally no research on retiring at 59yo+ and have no opinion on the matter. You can spread whatever information you want, though I find it largely irrelevant to the OP.

The question wasn't "what generic advice would a 40-something want" -- it was quite specific, with an age range and income bracket provided.  I recall a few links and a "those guys are wrong, despite the sources they cited, here are some other sources and why Roth might be better"...despite Traditional likely being the superior choice, which you just said yourself (and is also listed as the safer choice in the links you just posted).  I must be missing something, unless we're supposed to assume that everybody posting here, regardless of circumstances outlined in their post, are going to be retiring at social security age, collecting a pension, and contributing to a traditional IRA up until the year before they start withdrawing from it. Valid points, to be sure - but again, with a 20-something posting on an ER board? I'm not sure how well that fits.

The bogleheads wiki also agrees:

Tax considerations:

If your current marginal tax rate is 15% or less, prefer a Roth.[note 1]
If you expect to have higher marginal rates than your current marginal rate for most of your career, prefer a Roth.
If you will have a traditional account or a pension large enough to meet your expected retirement expenses (and you expect to take that pension shortly after retiring), prefer a Roth.[3]
Otherwise, prefer a traditional account.

Unless the OP has enough money to retire today, at least. I disagree with their second point; if my marginal rate is 25% now and will likely be 28% later, I will still contribute to a traditional 401k. Career marginal rate is irrelevant, as you noted earlier. What matters is rate at contribution and rate at withdrawal.

If you're simply disputing the way in which my post was phrased, and insist that it's wrong because it's not universally applicable to everybody's retirement situation - then sure, I agree. It's not.

[MDM]

I'd echo the posters here in saying that a Traditional 401k may be your better option but don't beat yourself up though over your past Roth contributions. You will be happy to have a pool non-taxable funds to withdraw from in retirement.

One exception would be that if you are maxing out your 401k in Roth contributions, you may want to continue to do so -- 18k post-tax is more than 18k pre-tax when you withdraw it.

And, if you have the funds, I would consider opening a Roth IRA for additional tax protection.

I would absolutely not do that. Changing your taxes from your current last dollar earned to your future first dollar earned is of dramatic benefit.

Ok, let's reset.  This is the exchange that had misleading (or "not always applicable", etc.) information, both pro-Roth and pro-traditional. 

Misleading pro-Roth: "18k post-tax is more than 18k pre-tax when you withdraw it."  Sure, an $18K balance in a Roth IRA is likely worth more than an $18K balance in a tIRA, but using that to imply "maxing out your 401k in Roth contributions" is always better is misleading.

Misleading pro-traditional: "Changing your taxes from your current last dollar earned to your future first dollar earned is of dramatic benefit."  Sure, if one could do that it would be a great benefit, but that's not how traditional accounts work in general and implying they always do is misleading.

If you're simply saying your advice to the OP is "use traditional now" - then sure, I agree. :)