Traditional 401(k)s are loans from the government? Let's hear your thoughts!

[icyappraiser]

A friend sent me this article. It makes sense on the surface, but I'm sure I am missing some of the opportunity costs and nuances. This forum seems to advocate traditional over ROTH when possible. I use a traditional based on the idea that my marginal rate now would likely be less than my effective rate later.

https://wealthyaccountant.com/2019/06/17/investing-in-a-retirement-account-is-like-taking-out-a-loan/

The author seems to say....

1. ROTH is better since there is no deferred tax
2. A regular brokerage account might even be better than a traditional 401k
3. Company matching is the exception he gives...you should still take that

What says the MMM community?

[Car Jack]

I think it's pretty standard to:

401k to the match
then Roth
then fill 401k

I have no HSA or other nonsense, so would have to do other things.

With a Roth, you don't increase RMDs.  Many people ignore RMDs because it's soooooo far in the future.  But ask people who are taking them, and they are all pissed that they have to take this money they don't need and now have to pay taxes.

In general, you have zero idea what your tax rate will be in retirement, so you have zero idea whether Roth or traditional are better.  You can strategize and have zero income for several years and do Roth conversions.  That certainly can work to change your traditional into tax free all around Roths. 

Taxable isn't better than either. 

[martyconlonontherun]

A friend sent me this article. It makes sense on the surface, but I'm sure I am missing some of the opportunity costs and nuances. This forum seems to advocate traditional over ROTH when possible. I use a traditional based on the idea that my marginal rate now would likely be less than my effective rate later.

https://wealthyaccountant.com/2019/06/17/investing-in-a-retirement-account-is-like-taking-out-a-loan/

The author seems to say....

1. ROTH is better since there is no deferred tax
2. A regular brokerage account might even be better than a traditional 401k
3. Company matching is the exception he gives...you should still take that

What says the MMM community?

I don't have the math on me, but isn't really situation dependent on how much you make now and how much you plan to pull out and when?

Someone pointed out he ignores the added value from the tax savings:
"Yaacov, I mentioned this, but it does get buried in the text. The added value of the retirement account/non-qualified account only grows larger than the after-tax traditional retirement plan contributions if you actually invest the tax savings. My experience is that virtually no client ever does this."
I guess for most people, this is true, but to FIRE-track people like me it isn't? It's like saying you are losing 2.9% on a car loan each month if you could've paid it off in cash, but ignoring that you could get way better returns if you are the type of person to reinvest unused capital.

For me, I have an after-tax limit per month in cash I can invest. I think I will have a lower tax bracket in the future so I would rather put in "more" pre-tax then "less" after tax.

He has a point, but his advice scare people. They see "Government takes more taxes from you----don't understand why since its super complicated" and then the reader gets disengaged and lowers their 401k. Instead of that, it should be start by contributing as much as you can to either side, and once you have that going, fine tweak it.

[RWD]

Some reading:
https://www.madfientist.com/traditional-ira-vs-roth-ira/
Investment Order

I max my 401k and both our Roth IRAs (income is too high for Traditional IRA). My wife has a mandatory fixed percentage contribution retirement account.

[EvenSteven]

This forum seems to advocate traditional over ROTH when possible.

I would disagree with this bit. If tax rate is higher now than it will be upon withdrawal, choose traditional. If tax rate is lower now than upon withdrawal, choose Roth. You don't have certainty about future tax situations, but you can make reasonable guesses, and having some tax diversification is probably a good idea.

The article is a bunch of innumerate hot non-sense.

[Wolfpack Mustachian]

A friend sent me this article. It makes sense on the surface, but I'm sure I am missing some of the opportunity costs and nuances. This forum seems to advocate traditional over ROTH when possible. I use a traditional based on the idea that my marginal rate now would likely be less than my effective rate later.

https://wealthyaccountant.com/2019/06/17/investing-in-a-retirement-account-is-like-taking-out-a-loan/

The author seems to say....

1. ROTH is better since there is no deferred tax
2. A regular brokerage account might even be better than a traditional 401k
3. Company matching is the exception he gives...you should still take that

What says the MMM community?

The forum answer, as I understand it, is predicated on the fact that you are making more money now than you will be needing in retirement. I agree with this perspective. If you are not, then you are spending all that you make and are not saving anything even for now, and you will be screwed in retirement. If you're making 50,000 and saving 10,000, then you are spending 40,000 and will hopefully spend this or less in retirement. Therefore, you should have lower taxes in retirement, because you should only be pulling out 40,000 instead of 50,000, which is what you would be fully paying taxes on now. This is very general, but I don't see many deviations from it.

[seattlecyclone]

The author's example is flawed. He points out that "Joe" would have only paid $3,000 in tax rather than $22,462 if he had gone with Roth, and implies that means Roth is better in this case. However he neglects to do a proper comparison of the quantity that matters: how much you get to keep after you pay your tax. In this example Joe's investments grew by a factor of 14.97 by the time he decided to withdraw.

In the original example where Joe chose traditional, he invested $10k pre-tax, it grew to $149.7k by retirement, and he paid $22.5k tax. This leaves him with $127.2k to spend.
If he had instead chosen Roth he would have paid his 30% tax on that $10k up front, invested $7k, and seen that investment grow to $104.8k. He gets to keep the full amount.

$127.2k is more than $104.8k. In fact the difference is about the same as the tax Joe paid, which makes sense because his tax rate during retirement was half of what it was while he was working.

Always look at your tax rates when making your traditional vs. Roth decision. Everything else is basically noise in comparison.

[kendallf]

The article is a bunch of innumerate hot non-sense.

^This.

The author's example is flawed. He points out that "Joe" would have only paid $3,000 in tax rather than $22,462 if he had gone with Roth, and implies that means Roth is better in this case. However he neglects to do a proper comparison of the quantity that matters: how much you get to keep after you pay your tax. In this example Joe's investments grew by a factor of 14.97 by the time he decided to withdraw.

In the original example where Joe chose traditional, he invested $10k pre-tax, it grew to $149.7k by retirement, and he paid $22.5k tax. This leaves him with $127.2k to spend.
If he had instead chosen Roth he would have paid his 30% tax on that $10k up front, invested $7k, and seen that investment grow to $104.8k. He gets to keep the full amount.

$127.2k is more than $104.8k. In fact the difference is about the same as the tax Joe paid, which makes sense because his tax rate during retirement was half of what it was while he was working.

Always look at your tax rates when making your traditional vs. Roth decision. Everything else is basically noise in comparison.

And this.  This guy says he has MMM for a client.  I hope he's a better accountant than he is at tax/investment advice.

[dandarc]

And this.  This guy says he has MMM for a client.  I hope he's a better accountant than he is at tax/investment advice.

I thought I recognized the URL.

[dandarc]

What says the MMM community?

Perhaps Vincent Gambini said it best:



Appears Keith has become another Financial Samurai - in it for the clicks and not to actually help people.

[jps]

What says the MMM community?

Perhaps Vincent Gambini said it best:



Appears Keith has become another Financial Samurai - in it for the clicks and not to actually help people.

He even has a forum on his site that looks suspiciously similiar to this one

[CorpRaider]

I mean the deferred federal income tax is like an interest free loan if the marginal rate at contribution and withdrawal are the same (i.e., all you are getting is tax deferral), but that is kind of like duh.   

I endorse the critical comments in this thread and the madfientist's analysis.

[wageslave23]

As a tax accountant and financial advisor I can say that this article is complete nonsense.  Its VERY simple - If you believe you have a higher marginal tax rate now than you will have when you pull the money out, then go with an IRA.  If you think you will have a higher marginal tax rate when you pull the money out then use a Roth IRA. 

I have personally run the scenarios both ways with online calculators and with excel sheets that I created.  The reason the FIRE community says to use traditional 401k and IRA is because its a no brainer.  The (correct) math doesn't lie.

[MDM]

I use a traditional based on the idea that my marginal rate now would likely be less than my effective rate later.

Perhaps you meant to say "would likely be more than..."?

Even if so, "effective rate" is not the appropriate comparison.  As wageslave23 said, compare marginal now vs. marginal at withdrawal.

[Buffaloski Boris]

I appreciated the article.  The author is one of the dissenting opinion generators amongst the FIRE community.  Dissenting opinions have a nasty tendency to become prescient over time, so they should at least be considered.

As other posters have noted, the key issue is marginal tax rates when you're working as compared to when you're retired.  But even this is somewhat flawed as almost everyone's analysis leaves off a key component of marginal tax rates: STATE income taxes. Those have to be paid as well.  If your plan in retirement is to move from a state that is relatively tax unfriendly to a state with lower or no income taxes, then that's an added argument for the traditional 401/IRA. If you plan to do the opposite, then Roth 401/IRAs could end up being preferred. 

One other problem; we don't really know what marginal tax rates will be say 20-30 years from now.

[DadJokes]

I usually enjoy Keith's articles, but he really misses the mark on this one. He tries to counter the math argument with this statement at the end:

Smart readers will also be quick to point out the extra tax savings means you have more to invest which mitigates any of the extra taxes owed in the future. This would be true if people actually did that.

When was the last time you invested your tax savings from a traditional retirement account investment? Where did you invest it? Uh-huh. Thought so. You spend the tax savings as most do.

Basically, his advice is not for those of us who are optimizing. It is for the people who are going to invest the same amount, regardless of which vehicle they use. If you are deciding between 19k in a Roth and 19k in a traditional where you will spend the tax savings instead of investing it, then maybe a Roth is better.

He also points out that for people with very high net worth, RMDs will eviscerate a traditional 401k/IRA balance, while a Roth account would be untouched. That's fine and all, but most of us aren't trying to reach an eight figure net worth.

What really frustrates me about his post is that he uses his own net worth, which is apparently over $10 million, as proof that he is more right than bloggers who have less money. He links some website where he is apparently the wealthiest finance blogger as proof. Of course, I didn't see any bloggers that I'm familiar with (such as MMM or Big ERN), so it's not a very thorough list.

[Paul der Krake]

I couldn't care less about my tax efficiency in my 70s when I'm a multimillionaire. I care much more setting aside as much as possible when I'm young, and the way to do this is with pre-tax vehicles.

[swinginbeef]

I couldn't care less about my tax efficiency in my 70s when I'm a multimillionaire. I care much more setting aside as much as possible when I'm young, and the way to do this is with pre-tax vehicles.

But aren't you theoretically doing the same thing by investing in a Roth and paying taxes today? The taxes you pay today will save you the higher amount of taxes in the future, at a similar growth rate as your account balance. The only true difference is your tax rate today vs your tax rate in retirement.

Invest $19k, pay $4750 (20%) tax now and withdraw tax free or invest $23750 today and pay 20% on the future balance gives you the exact same money in hand at the end.

[DadJokes]

I couldn't care less about my tax efficiency in my 70s when I'm a multimillionaire. I care much more setting aside as much as possible when I'm young, and the way to do this is with pre-tax vehicles.

But aren't you theoretically doing the same thing by investing in a Roth and paying taxes today? The taxes you pay today will save you the higher amount of taxes in the future, at a similar growth rate as your account balance. The only true difference is your tax rate today vs your tax rate in retirement.

Invest $19k, pay $4750 (20%) tax now and withdraw tax free or invest $23750 today and pay 20% on the future balance gives you the exact same money in hand at the end.

But the tax rate isn't equal, largely because of standard/itemized deduction.

An example: https://drive.google.com/open?id=1v3c_ekBW4bLsR8c5Fpk-2GhiY40ZY2i6

[swinginbeef]

But the tax rate isn't equal, largely because of standard/itemized deduction.

Google docs are blocked here, so I can't check it out, but I agree that tax rates may not be the same.  He seemed to be saying that getting the most money into the investment accounts is his main driver and that may not always be the best route. I guess I should have added "Effective" to my tax rate comment. But I definitely agree than in the situations of the majority around here (Average to Above Average income and Below Average spending), Traditional is the way to go.

[MDM]

But the tax rate isn't equal, largely because of standard/itemized deduction.

An example: https://drive.google.com/open?id=1v3c_ekBW4bLsR8c5Fpk-2GhiY40ZY2i6

But the tax rate isn't equal, largely because of standard/itemized deduction.

I guess I should have added "Effective" to my tax rate comment.

See the commutative property of multiplication as it applies here.

Also note that one adds to traditional accounts year by year, not all at once.  After there is enough in the traditional account for projected withdrawals to exceed the standard deduction, that deduction becomes irrelevant for for future traditional contributions, making future marginal - not effective - rates the one to use for comparison.

[Paul der Krake]

I couldn't care less about my tax efficiency in my 70s when I'm a multimillionaire. I care much more setting aside as much as possible when I'm young, and the way to do this is with pre-tax vehicles.

But aren't you theoretically doing the same thing by investing in a Roth and paying taxes today? The taxes you pay today will save you the higher amount of taxes in the future, at a similar growth rate as your account balance. The only true difference is your tax rate today vs your tax rate in retirement.

Invest $19k, pay $4750 (20%) tax now and withdraw tax free or invest $23750 today and pay 20% on the future balance gives you the exact same money in hand at the end.

Theoretically yes, assuming similar tax rates when working and in retirement (which is a big assumption, but let's roll with it). It's still beneficial because the goal isn't to pay the fewest taxes possible, it's to get the freedom to do what I want ASAP. The closer to death I am, the more secure I am in having secured the life I want for myself.

[DadJokes]

With a Roth, you don't increase RMDs.  Many people ignore RMDs because it's soooooo far in the future.  But ask people who are taking them, and they are all pissed that they have to take this money they don't need and now have to pay taxes.

RMDs are a real concern for a lot of people, though probably not in the FIRE community. I'm planning on retiring at 50, and projecting 20 years after that, my RMDs (adjusted for inflation) would be over $80k - $30k over my planned withdrawals.

Of course, that means I have 20 years after retiring to shift as much of that money over to a Roth as I can. That shouldn't be a problem.

So, for the person who never plans to stop making money, RMDs are definitely something to keep in mind when planning. For those of us will have a couple decades of low income years to shift money into a Roth, it's not really relevant.

[KeithTax]

What says the MMM community?

Perhaps Vincent Gambini said it best:



Appears Keith has become another Financial Samurai - in it for the clicks and not to actually help people.

He even has a forum on his site that looks suspiciously similiar to this one

His forum looks the same because the same guy manages both blog's forums (Kevin Clack; MMM and TWA both promote him). He also did Pete's taxes and is his tax advisor.

[teen persuasion]

His premise might make sense for high income earners who plan to work right up to RMD age (no chance to Roth convert during ER).

It's completely wrong if you might be eligible for refundable credits like EITC.

Contributing to traditional 401k (not IRA) increases our EITC, because it reverses the 21% phaseout (and an additional 6.3% phaseout for the 30% state EITC match).  That's on top of the 10% federal and 4% state taxes deferred, and the EITC phaseout "tax" won't be recaptured at withdrawal time in retirement.  In fact, the state tax won't be assessed, either, on the first $20k each of us withdraws annually in retirement and after age 59.5.  So 21 + 6.3 + 10 + 4 = 41.3% bonus tax refund for contributing to traditional 401k accounts, and the possibility of only federal 10% tax on withdrawal.

And, yes, I DO save the refunds - they fund our Roth IRAs.  At that point, there's no more tax advantage to be gotten from a tIRA, because we've reached zero federal tax owed (due to nonrefundable credits), and because IRA contributions can't increase EITC (IRA contributions can't lower w2 wages).

[kendallf]

His forum looks the same because the same guy manages both blog's forums (Kevin Clack; MMM and TWA both promote him). He also did Pete's taxes and is his tax advisor.

By "His" and "he" I assume you mean "My" and "I"? 

Yes, people are piling on with criticism but reading your comments on your own blog and your prior posts here, you seem level headed and able to defend your views.  I just think that was not a well thought out post, as others have enumerated here.  Your wealth is not a qualifier for your advice; if it was, we'd all be taking advice from that Level Headed Genius (tm), Donald Trump.

[roomtempmayo]

Perhaps it's not surprising that the author of the article is transparently lacking in qualifications.  His primary skill seems to be spinning out "what if?" scenarios that make people anxious and presumably lead to him getting paid.

The straightforward answer to the Roth/traditional question is, as pretty much every reputable source of financial advice says:

Its VERY simple - If you believe you have a higher marginal tax rate now than you will have when you pull the money out, then go with an IRA.  If you think you will have a higher marginal tax rate when you pull the money out then use a Roth IRA. 

My even simpler approach to the issue is to exceed the Roth income cap pronto so as to render all of this handwringing irrelevant.