Article - Why 91% of People Shouldn’t Invest In a Roth 401k

[Montecfo]

You want both Roth and traditional so you can have more control over your income. Things like ACA insurance, tax torpedo, IRMAA, RMDs benefit from lower taxable income, but you still need some income for ACA and you want enough income to at least use up your standard deduction every year.

I tell my kids when they are young and not earning big bucks, they should contribute to a Roth and in their peak earning years they should contribute to a regular 401k.

With respect, at all ages I think you have to look at tax rates, not just earnings.

These single taxpayers pay higher rates than MFJ.

If you marry and one stays home with kids, THAT could be a favorable bracket. But also a time when funds are tight of course.

But again it is hard to know even that so many years in advance.

But understand that this is only dealing with pre-tax versus Roth. If you max out your pre-tax opportunities, the case for Roth versus taxable is a bit more clearly in favor of the Roth.

That is the better way to address the desire for tax diversity: max out pre-tax then fund Roth to the extent you can.

 

[CardsFan]

I'll tell you one: You can save more tax-advantaged money that way. My wife and I maxed ours out for years. If we had maxed our Traditional 401ks we wouldn't have been able to save as much in that account. There are possible downsides, too, but that's the advantage.

You are assuming a person will invest the same amount money, whether it is before tax or after tax.

If I maxed out my t401k at $27,000 (over 50), and avoided 24% tax rate, I have another $6480 (the tax savings) I can invest in after tax accounts

 

[arcyallen]

OK, thanks for explanation. But why didn't you max out after tax 401K instead? There is a limit much higher than for regular/Roth 401K.

By "after tax 401k", are you referring to something other than a Roth 401k (which uses after tax dollars)? Or something else? I'm not sure what you're referring to.

You are assuming a person will invest the same amount money, whether it is before tax or after tax.

If I maxed out my t401k at $27,000 (over 50), and avoided 24% tax rate, I have another $6480 (the tax savings) I can invest in after tax accounts

I'm suggesting this for the person who wants to maximize the opportunity. That's why I said "You can save more tax-advantaged money that way." For simple math let's say you pay 20% income tax and you're making $100k/yr but only want to save $5k/yr. You can do that in either account. But if you're over 50 and want to maximize your savings, you can either put in $30k pre-tax and owe tax in the future on it (netting $24k later and getting tax savings today), or put in $30k tax free and know you'll never get taxed on it again netting the full $30k. Another way to look at it is it's like virtually raising the contribution limit.

 

[Qs Laptop]

It just ends up different versions of the same decision... if you think that your marginal tax rate in retirement will be lower than your current marginal tax rate then contribute to tax deferred... if you think that your marginal tax rate in retirement will be the same or higher than your current marginal tax rate the contribute to tax-free.

Yes, but it can be tricky knowing how to proceed. For 25 of the past 30 years DW and I had been maxing out tax deferred 401k and IRAs on our modest salaries. I always thought there would be Roth conversions in my future. I invested this tax deferred money aggressively, did well, and figured with RMDs and SS income we would have higher take home income in retirement than we were while working.

Figuring our Roth side was lacking I switched us over to 100% Roth 401k contributions. Complicating things, in the past several years we're both enjoying significantly higher incomes and have moved up to the next tax bracket.

So now the question of whether or not we should do Roth conversions is clear as mud. I'm glad I switched over to 100% Roth contributons because at least I will have some flexibility when it comes to retirement income. In my situation, it seems that's the best I can do. But as to future Roth conversions, I'm paralyzed with indecision.

 

[Alex The Great]

By "after tax 401k", are you referring to something other than a Roth 401k (which uses after tax dollars)? Or something else? I'm not sure what you're referring to.

Yes "after tax 401K" is different from "Roth 401K".
Both regular and Roth 401K share a total limit of $30K including catch-up (2023) it does not matter where you contribute (regular or Roth or both).
After tax 401K has a higher limit of $73,500 (2023) but this is a total limit for regular/Roth 401K including employer's match and after tax 401K.
You can find details here for example:
https://www.bankrate.com/retirement/after-tax-401k/

As pointed out by other folks 401K Roth make sense for those with tax bracket in retirement anticipated to be higher than during career times. Which I believe is a rare case. At least, I've been in extremely high tax bracket all the time since graduation. But investing into Roth IRA is important too and after tax 401K is designed exactly for that purpose as it is not a replacement for regular 401K but a valuable addition.

 

[NW-Bound]

Roth 401k was not available in our working years. We always maxed out our 401k contributions, and had excess money to save in after-tax accounts. It is the after-tax money that allowed us to retire early, because our 401ks were not accessible prior to 59-1/2 without going through 72(t) rule.

Don't know about Roth 401k, but if I could have that after-tax money in a Roth IRA, that would work better, but alas, I was above the income limit, so no Roth IRA for me either.

 

[rothlev]

Just the headline is false...



Over 50% of people pay zero or very little taxes... there is NO reason for these people to invest in a regular 401 so all earnings in the future will be taxed...


There is a big reason for them to invest in a ROTH... NO TAXES....


So, if anybody read the article and can find a reason that what I say is wrong let me know...

My experience doing taxes is a lot of modest income retirees pay little to 0 in taxes. (. mostly due to the way social security is taxed ) generally once the children are out of the nest most pay tax while working. the child tax credits and the earned income credits wash a lot of the tax for working folks. So, if you are low/0 tax household a roth is a good deal. if you are a modest income household . paying taxes the traditional is likely better.

 

[tulak]

In my view, it doesn't make a lot of sense to contribute to a regular 401k to avoid 22% tax now only to pay 22% when I take it out. Among other reasons are that everything we take out of the tax deferred accounts is taxed as regular income, although it would be taxed as capital gains and/or qualified interest if held in a taxable account. You also cannot tax loss harvest in a tax deferred account.

When I started saving in a 401k, I did it because I wanted to retire some day. I didn’t know about tax arbitrage and other options. Now I max my 401k because I’m in a higher tax bracket. I’m 50/50 if it’s the right approach.

DS is smarter. He’s in a lower tax bracket and only saves in the 401k up to the company match. I imagine he’ll contribute more once he’s in a higher tax bracket.

I’ll have to ask him if he’s contributing to a Roth.

 

[tulak]

Yes "after tax 401K" is different from "Roth 401K".
Both regular and Roth 401K share a total limit of $30K including catch-up (2023) it does not matter where you contribute (regular or Roth or both).
After tax 401K has a higher limit of $73,500 (2023) but this is a total limit for regular/Roth 401K including employer's match and after tax 401K.
You can find details here for example:
https://www.bankrate.com/retirement/after-tax-401k/

Another description can be found here: https://www.bogleheads.org/wiki/After-tax_401(k)

Along with https://www.bogleheads.org/wiki/Mega-backdoor_Roth

For those whose plans allow it, this strategy allows for large contributions to Roth accounts (theoretically up to $66,000, but more typically $43,500 minus any employer match), which are in addition to direct contribution limits to a Roth IRA, and to a 401(k) through elective salary deferrals. Tax-free growth on this money adds up to a large tax savings over an investor's lifetime.

It’s a great setup if you have access to one.

 

[oiseux]

Did anyone click through the tools? The author seems to be intent on selling their spreadsheet. The free one is basic -- it is not clear the pay version actually captures different types of revenue streams, their different tax treatments and things like SS torpedo and IRMA impacts (although these may be secondary for many people). The author of course touts the spreadsheet when the advice can be condensed as people related above: pick traditional 401K first if you are in a higher rate today. What the article doesn't mention (and the spreadsheet doesn't handle) are the more complex questions regarding what happens with a mix of pre- and post tax investment strategies plus conversions. It would be more helpful to outline the situations where this assumption breaks down.

ETA: And of course, the 91% headline claim is based on a non random selection of users, thus is likely not representative of a full population.

ETA2: Looks like the paid version does allow for multiple sources of income in retirement (though not in pre). Not liking the lack of input flexibility on age and income for couples, and no signs if things like SS and IRMAA are comprehended.

 

[Koolau]

By "after tax 401k", are you referring to something other than a Roth 401k (which uses after tax dollars)? Or something else? I'm not sure what you're referring to.



I'm suggesting this for the person who wants to maximize the opportunity. That's why I said "You can save more tax-advantaged money that way." For simple math let's say you pay 20% income tax and you're making $100k/yr but only want to save $5k/yr. You can do that in either account. But if you're over 50 and want to maximize your savings, you can either put in $30k pre-tax and owe tax in the future on it (netting $24k later and getting tax savings today), or put in $30k tax free and know you'll never get taxed on it again netting the full $30k. Another way to look at it is it's like virtually raising the contribution limit.

It's very much like converting a tIRA to Roth but paying the taxes from cash you have on hand (IOW - not from the tIRA) In essence, you increase the Roth value by whatever taxes you paid.

Thank you sharing on Roth 401(k). I never had the option but it sounds like many still w*rking should consider it.

 

[Texas Proud]

Yes, but it can be tricky knowing how to proceed. For 25 of the past 30 years DW and I had been maxing out tax deferred 401k and IRAs on our modest salaries. I always thought there would be Roth conversions in my future. I invested this tax deferred money aggressively, did well, and figured with RMDs and SS income we would have higher take home income in retirement than we were while working.

Figuring our Roth side was lacking I switched us over to 100% Roth 401k contributions. Complicating things, in the past several years we're both enjoying significantly higher incomes and have moved up to the next tax bracket.

So now the question of whether or not we should do Roth conversions is clear as mud. I'm glad I switched over to 100% Roth contributons because at least I will have some flexibility when it comes to retirement income. In my situation, it seems that's the best I can do. But as to future Roth conversions, I'm paralyzed with indecision.

Just to summarize what i read... you invested in regular 401 when you had lower taxes... you now have higher taxes and are investing in ROTH 401...


That seems really backwards to me... if someone is not in a high tax bracket than investing in a ROTH seems like the best thing to do... you co not have to worry about ROTH conversions later in life when you have made a lot of money in the regular account... and you have a lot of space to invest in regular when you are in a higher tax bracket..

 

[djsander]

We have Roth IRA accounts and a roth 401k wasn’t available at work until the last ten years. We are in a much lower bracket now and not expecting to be in a higher bracket until one of us dies. So we do the conversions. However, I speculate based on averages women live three years longer than men and my wife is 3 years and 20 days older than me. So by the averages she should die right before me and all this worrying about taxes for the survivor will be for nothing.

 

[CardsFan]

We have Roth IRA accounts and a roth 401k wasn’t available at work until the last ten years. We are in a much lower bracket now and not expecting to be in a higher bracket until one of us dies. So we do the conversions. However, I speculate based on averages women live three years longer than men and my wife is 3 years and 20 days older than me. So by the averages she should die right before me and all this worrying about taxes for the survivor will be for nothing.

When folks quote averages, my standard comment is: put one foot in a pot of boiling water, and the other in a bucket of ice water. On Average, you are comfortable.

Yeah, I know, if you look at the thermodynamic formulas this is not exactly true, but you get the drift.

 

[djsander]

When folks quote averages, my standard comment is: put one foot in a pot of boiling water, and the other in a bucket of ice water. On Average, you are comfortable.

Yeah, I know, if you look at the thermodynamic formulas this is not exactly true, but you get the drift.

I know that as well. Actually, more correctly would be by the actuarial tables by the SS administration we should die pretty close to the same time. Those tables use a lot of statistical data. Even that can be an anomaly as people may live shorter or longer. I’m actually erring on the conservative side and get the money out of the Tira while in a known low tax bracket. Better to try to get that down and one lives along time than get stuck with a higher tax bill due to RMDs or higher single tax rates.

 

[House Divided]

I always maxed out my 401k that was usually limited to what I could contribute as a highly compensated employee. Then I maxed out my tIRA then I maxed out my non-working DW's tIRA then I maxed out my Roth IRA. I've been retired for 11+ and been able to to stay in the 12% tax bracket and manage my income for maximized ACA subsides before Medicare. Now that I am 66 I've been taking more out of tIRA each year but still in the 12% bracket. So tIRA has worked out for me.

 

[Koolau]

When folks quote averages, my standard comment is: put one foot in a pot of boiling water, and the other in a bucket of ice water. On Average, you are comfortable.

Yeah, I know, if you look at the thermodynamic formulas this is not exactly true, but you get the drift.

Yeah, I don't know about all that when it comes to living to a ripe old age.

But I really like those statistics suggesting that the longer you live, the longer, well, you know, the longer you will live. What a concept!

 

[bada bing]

One thing not addressed by the article/ad and not common in analysis of the Roth vs Trad question is the self limiting nature of the tax advantages of pre-tax contributions. It is like a tax see-saw, where contributions today lower your current tax rate, but increase it in the future. Save enough pre-tax for long enough and you'll undo the tax arbitrage that is the basis for choosing pre-tax contributions in the first place. Granted, it takes a pretty hefty balance in traditional for most individual situations, but not outside the experience of long term dedicated savers, especially those with pensions and large SS checks. I suspect several members here may have put more into pre-tax over a career than was optimum. In my case, it looks like $1.2M balance in pre-tax when RMDs start is going to undo the tax advantage I received on the contributions. Depending on market performance over the next 8 years, I very likely should have put some of my pre-tax contributions into Roth instead. If I live into my 90's and the market has a good few decades, the eventual tax consequences are pretty large. 1st world problems, but an issue totally overlooked by the article/ad.

TL-DR Your anticipated pre-tax balance at RMD age is a major factor in choosing Roth/pre-tax while working.

 

[Gumby]

I think some important things many people overlook when running these calculations is that the Roth IRA was unavailable until the 1998 tax year, that it has always had relatively low limits on the amount of allowed contributions and that it was phased out and eventually eliminated for those over a certain AGI. For the vast majority of the 20 years between the time Roth's started and we retired, the young wife and I were entirely ineligible to contribute to a Roth. There was a short period (one or two years) when I first left private practice where we were eligible to contribute a few hundred dollars, so we did. And a good thing, because now we can do Roth conversions.

Traditional IRA's also have always had paltry contribution limits and an AGI threshold for deductibility. We did contribute to tIRA's at first, but stopped when we could no longer do it pre-tax, which was back in the 90s. So, essentially, our choice was 401k, 403b, 457 or taxable saving. During the years when we were avoiding marginal federal tax rates of 39.5%, it was an easy choice, and we will never get back to that bracket in retirement.

EDIT TO ADD:

Also overlooked is the fact that, for those who are fortunate to have a 401k match, it would be foolish not to contribute in order to take advantage of that match.

 

[Qs Laptop]

Just to summarize what i read... you invested in regular 401 when you had lower taxes... you now have higher taxes and are investing in ROTH 401...


That seems really backwards to me...

Yes, it probably is...

For years my wife was in a tax deferred 401k plan at work. At tax prep time, because of our income levels it was advantageous for us to contribute to a trad IRA. Doing this flipped our tax return from owing taxes to getting a refund. We were putting $12K in our IRAs and the government was sending us money. Win-win.

Then I realized I didn't have any money saved in Roth's. So, just in the interest of having flexibility with future RMAs I switched to Roth's, in both our workplace 401k's.

if someone is not in a high tax bracket than investing in a ROTH seems like the best thing to do... you co not have to worry about ROTH conversions later in life when you have made a lot of money in the regular account... and you have a lot of space to invest in regular when you are in a higher tax bracket..

When you say "regular account", do you mean a typical taxable brokerage account? (And not a traditional tax deferred IRA or 401k account?)

 

[punkinhead]

A friend of mine was in awe of an executive coworker who has 100% of his 401K/IRA money (to the tune of $10M) in Roth. I can't think of any way that could be done without doing it in an incredibly high marginal tax rate. I'm sure it would feel awesome to be retired with that much money in Roth but mathematically I very much doubt it was the most tax efficient thing to do.

 

[oiseux]

A friend of mine was in awe of an executive coworker who has 100% of his 401K/IRA money (to the tune of $10M) in Roth. I can't think of any way that could be done without doing it in an incredibly high marginal tax rate. I'm sure it would feel awesome to be retired with that much money in Roth but mathematically I very much doubt it was the most tax efficient thing to do.

This sometimes comes as a result of a self directed IRA that might include private shares and real estate (with high growth potential, like startup shares) plus an aggressive (re)investment strategy. The leading example of this is Peter Thiel, with Billions in Roth (from $2K in 1999).

 

[qwerty3656]

Barrons article says the opposite - almost all workers should contribute to Roth

https://www.barrons.com/articles/roth-401k-ira-retirement-savings-b62194f3

 

[CardsFan]

Pay wall.

 

[karen1972]

Why does the Roth 401k net you more money in retirement?

It’s simple. You’re contributing more out-of-pocket dollars by investing the same amount into a Roth (since you’re using after-tax dollars).

Remember the example above? A $10,000 contribution into a 401k saves you $2,200 in taxes, so you’re effectively only paying $7,800.

By investing in a Roth, you’re essentially paying $2,200 in taxes and still investing $10,000 into the Roth.

Sure, it’ll net you more in retirement, but only because you’re shelling out an additional $2,200 to do it!

I'm pretty sure based on their logic, their calculator "fixes" this and if so all their math is extremely flawed.


I don't usually like any of these discussions because the reality is the decision of Roth/Traditional 401k should be done on a year by year basis and can change throughout time as laws change, rates change, you change jobs, you suddenly inherit money, etc... and its not a 100% either/or. My honey contributes enough pre-tax to reduce his income to just under the next tax bracket and then dumps the rest into his Roth 401k.

I put into the traditional 401k as a single high earner, figured I needed the tax breaks. One additional perk I hadn't planned on was that by the time I took it out I'd be married thus lowering my tax bracket even more.