If your retirement tax rate is as high or higher than your present tax rate do a Roth and sometimes even if the tax rate in retirement is less. If the tax rate is unchanged, you end up with the same amount of after tax money with a Roth or a tax deferred IRA. For example, if you are in the 35% tax bracket and invest $8,000 in a tax deferred IRA and it quadruples to $32,000 before you take it out in retirment, you then pay $11,200 in tax (still 35% bracket) and are left with $20,800 after tax. If you do a Roth you have to pay the $2,800 tax on the $8,000 and are left with $5,200 to put in the Roth. That quadruples to the same $20,800. It is also after tax money too since a Roth is not taxed. It has other advantages including no RMD and ability to grow 10 years tax free after inheritance. If you have extra cash a Roth can often make sense even if rate will be lower in retirement especially if that money can grow for a long time. In the above example, if you can pay the 35% tax with $2,800 from a taxable brokerage account the Roth now has $8,000 that grows to $32,000 after tax. However you have lost the $2,800 that would have grown in the taxable brokerage account. Let's say that would have also quadrupled to $11,200 and assume you only had to pay a 20% capital gains tax on the growth leaving $9,520 after tax. You are now down in the 32% rather than the 35% tax bracket. The tax deferred IRA has grown to $32,000 and is worth $21,760 after the 32% tax is paid. After tax you now have $21,760 from the IRA and $9,520 from the brokerage account for a total of $31,280 after tax. This is $720 less than the $32,000 the Roth was worth after tax! In this case even though the tax bracket in retirement fell from 35% to 32% you ended up with more money doing the Roth and all the other advantages of a Roth too! The same is true comparing Roth and non Roth 401K and 403B as long as there is money available in a taxable account to pay the extra tax when you do a Roth rather than needing to reduce the amount you put into the Roth to have money to pay the tax. You can look at it as the difference between investing the tax money to grow tax free in a Roth versus growing in a taxed growth. The former always wins at the same tax rate in retirement and can often win even when the retirment tax rate falls.
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If your retirement tax rate is as high or higher than your present tax rate do a Roth and sometimes even if the tax rate in retirement is less. If the tax rate is unchanged, you end up with the same amount of after tax money with a Roth or a tax deferred IRA. For example, if you are in the 35% tax bracket and invest $8,000 in a tax deferred IRA and it quadruples to $32,000 before you take it out in retirment, you then pay $11,200 in tax (still 35% bracket) and are left with $20,800 after tax. If you do a Roth you have to pay the $2,800 tax on the $8,000 and are left with $5,200 to put in the Roth. That quadruples to the same $20,800. It is also after tax money too since a Roth is not taxed. It has other advantages including no RMD and ability to grow 10 years tax free after inheritance. If you have extra cash a Roth can often make sense even if rate will be lower in retirement especially if that money can grow for a long time. In the above example, if you can pay the 35% tax with $2,800 from a taxable brokerage account the Roth now has $8,000 that grows to $32,000 after tax. However you have lost the $2,800 that would have grown in the taxable brokerage account. Let's say that would have also quadrupled to $11,200 and assume you only had to pay a 20% capital gains tax on the growth leaving $9,520 after tax. You are now down in the 32% rather than the 35% tax bracket. The tax deferred IRA has grown to $32,000 and is worth $21,760 after the 32% tax is paid. After tax you now have $21,760 from the IRA and $9,520 from the brokerage account for a total of $31,280 after tax. This is $720 less than the $32,000 the Roth was worth after tax! In this case even though the tax bracket in retirement fell from 35% to 32% you ended up with more money doing the Roth and all the other advantages of a Roth too! The same is true comparing Roth and non Roth 401K and 403B as long as there is money available in a taxable account to pay the extra tax when you do a Roth rather than needing to reduce the amount you put into the Roth to have money to pay the tax. You can look at it as the difference between investing the tax money to grow tax free in a Roth versus growing in a taxed growth. The former always wins at the same tax rate in retirement and can often win even when the retirment tax rate falls.
Post: Do you favor Roth or traditional retirement accounts, and why?
Link to comment from May 13, 2024