Roth vs Traditional for the Typical FIRE

[wageslave23]

Let's assume married couple retiring at 45, with a FIRE budget of 50k. Let's also assume they are in the 22% tax bracket while working.  Has anyone done an analysis on whether it's better to save with Roth or Traditional 401k contributions? A couple things to consider would be future tax bracket. I think it's easiest to assume that the brackets will be similar to what they currently are since they could increase or decrease. The next would be ACA subsidies. I think it would be safest to use the subsidy amounts that it will revert to once the current temporary higher subsidies sunset. Final consideration is Medicare premiums and social security taxability. 

[ixtap]

Even if taxes go up across the board, if your savings rate was high enough to retire at 45, you will likely be in a lower tax bracket once retired, if you keep your spending level similar. For many FIRE folks, even paying the 10% penalty would represent a tax savings.

[Morning Glory]

Mad Fientist has a nice analysis on his site, the article is older but it looks like he updated it to reflect current tax brackets.

https://www.madfientist.com/traditional-ira-vs-roth-ira/

[Catbert]

Federal tax rates are scheduled to go up in 2026.  22% will be 25%.

[ixtap]

Oh, I forgot to add that you will need some income to qualify for ACA. We expect to have to do Roth conversions to generate enough income, even if they are small most years.

[wageslave23]

I agree from purely an income tax perspective, traditional is the way to go. But that doesn't take ACA subsidies into account.  And with a family or even childless couple that's a major factor.

[seattlecyclone]

So, even if all of your spending counts as regular income, the $50k income needed for your budget is solidly in the middle of the 12% bracket for a married couple (scheduled to be 15% in two years if Congress does nothing). $50k is also roughly 2.5x the poverty level for a two-person family. That would put you in the range where the ACA phase-outs would tack on another ~15%. The sum of those two marginal rates is higher than the 22% you're paying now, so perhaps it would be worth locking in some Roth savings at 22% so that you can keep your overall rate lower than that during your ACA insurance years.

Those years won't last forever though! Once you turn 65 and get on Medicare the ACA tax goes away, so you'd once again be looking at 12-15% even if you're pulling all of your budget from traditional IRAs. There is IRMAA that acts as an additional tax for Medicare users, but that doesn't take effect until over $103k income (single) or $206k (married). That's 2-4x your expected budget, so even if RMDs kick you up in that range that's a sign you ended up with a lot more money than you needed, and maybe a bit of extra tax isn't the end of the world in that case.

[moof]

Another twist: ACA subsidy phase-out is a de-facto tax you should factor in.

In my own case it works out to 9.5% above the 400% FPL, so if I am in the 22% bracket now, but will be in 12% during retirement.  I drop to effectively only 21.5% combined federal+ACA net marginal tax rate.  If I am close to filling up the 12% bracket I may fall into a net 31.5% marginal rate for any lumpy expenses.

[Dee18]

It's far down the road for some, but a higher income in retirement can have many consequences besides just income tax.  The surcharges for Medicare Part B go up to $350 per month per person, so up to $4200/year for an individual.  Some states, such as Vermont, give huge property tax rebates for incomes below six figures (or more).  I wish I had put most of my retirement accounts in Roth, which my employer allowed the last decade of my employment.  On the other hand, I would not put it all in Roth (as one of my colleagues did) because I plan to give a fair amount to charities which I can do tax free from my regular IRAs after age 72.5.

[mcneally]

A couple in the 22% tax bracket is making a minimum of $122k and possibly as much as $209k. If you really expect to spend $50k (today's dollars) in retirement, it seems clear to me the answer is to max traditional 401k and Roth IRA (you make too much for deductible traditional IRA). If tax/ ACA rules remain similar, you'll still qualify for very low cost ACA insurance.

[seattlecyclone]

A couple in the 22% tax bracket is making a minimum of $122k and possibly as much as $209k. If you really expect to spend $50k (today's dollars) in retirement, it seems clear to me the answer is to max traditional 401k and Roth IRA (you make too much for deductible traditional IRA). If tax/ ACA rules remain similar, you'll still qualify for very low cost ACA insurance.

No, the point of the question is that traditional is not a clear win. Although the dollar cost of the ACA insurance at a $50k income level is relatively low, the effect a marginal dollar of income at that point will have on the combination of their income taxes plus ACA subsidies could very well be higher than the 22% they're paying now. And if that is the case, that could point toward making some Roth contributions now so that their income during the ACA portion of their retirement can held below their $50k spending target.

[mcneally]

A couple in the 22% tax bracket is making a minimum of $122k and possibly as much as $209k. If you really expect to spend $50k (today's dollars) in retirement, it seems clear to me the answer is to max traditional 401k and Roth IRA (you make too much for deductible traditional IRA). If tax/ ACA rules remain similar, you'll still qualify for very low cost ACA insurance.

No, the point of the question is that traditional is not a clear win. Although the dollar cost of the ACA insurance at a $50k income level is relatively low, the effect a marginal dollar of income at that point will have on the combination of their income taxes plus ACA subsidies could very well be higher than the 22% they're paying now. And if that is the case, that could point toward making some Roth contributions now so that their income during the ACA portion of their retirement can held below their $50k spending target.

If you're e spending $50k, you're not going have income of $50k because you'll have some basis in your taxable brokerage/ HYSA, etc. You'd probably need to do extra Roth conversions just to get out of Medicaid territory and still get free ACA insurance.

I did do some Roth 401k my last year working for that reason though because my spending is more like low $30s as a single person.

[seattlecyclone]

A couple in the 22% tax bracket is making a minimum of $122k and possibly as much as $209k. If you really expect to spend $50k (today's dollars) in retirement, it seems clear to me the answer is to max traditional 401k and Roth IRA (you make too much for deductible traditional IRA). If tax/ ACA rules remain similar, you'll still qualify for very low cost ACA insurance.

No, the point of the question is that traditional is not a clear win. Although the dollar cost of the ACA insurance at a $50k income level is relatively low, the effect a marginal dollar of income at that point will have on the combination of their income taxes plus ACA subsidies could very well be higher than the 22% they're paying now. And if that is the case, that could point toward making some Roth contributions now so that their income during the ACA portion of their retirement can held below their $50k spending target.

If you're spending $50k, you're not going have income of $50k because you'll have some basis in your taxable brokerage/ HYSA, etc.

This really depends on how much they have saved in each account type. I've seen people on this forum who have essentially all of their stash in retirement accounts, so withdrawing from those other accounts you mentioned is not part of their plan. If these folks go all in pre-tax contributions now to enable a Roth ladder later, a typical year in retirement could very easily see them have income higher than their spending, since they'd want to do a Roth conversion big enough to enable $50k of spending in five-years-from-now dollars.

The choice of traditional vs. Roth largely does come down to what's your marginal rate when you're putting that dollar in, versus what do you expect your marginal rate to be when you would be withdrawing (or Roth-converting) that dollar? In the case of some early retiree purchasing health insurance from their state's ACA Marketplace with income in the ballpark of $50k, the marginal rate would very likely be more than 22%. This depends very much on what sort of account mixture they intend to retire with, how much they plan to withdraw from each account in a year, whether they want to aim for Medicaid or aim to avoid it or just take whatever comes from their income, etc.

[wageslave23]

So, even if all of your spending counts as regular income, the $50k income needed for your budget is solidly in the middle of the 12% bracket for a married couple (scheduled to be 15% in two years if Congress does nothing). $50k is also roughly 2.5x the poverty level for a two-person family. That would put you in the range where the ACA phase-outs would tack on another ~15%. The sum of those two marginal rates is higher than the 22% you're paying now, so perhaps it would be worth locking in some Roth savings at 22% so that you can keep your overall rate lower than that during your ACA insurance years.

Those years won't last forever though! Once you turn 65 and get on Medicare the ACA tax goes away, so you'd once again be looking at 12-15% even if you're pulling all of your budget from traditional IRAs. There is IRMAA that acts as an additional tax for Medicare users, but that doesn't take effect until over $103k income (single) or $206k (married). That's 2-4x your expected budget, so even if RMDs kick you up in that range that's a sign you ended up with a lot more money than you needed, and maybe a bit of extra tax isn't the end of the world in that case.

Thanks. This is the simple clear minded answer I was looking for. All of these things could change so no one knows what's best but it seems like maxing traditional 401k and then adding roth ira is a safe bet.