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

[Earl E Retyre]

Not sure if the below article is hogwash or true so figured I would post it here to find out ... the article rambles a bit and pushes an online calculator which I was not going to do.

https://lifeandmyfinances.com/retirement/roth-401k-calculator

Some quotes:
- I started investing in a Roth ten years ago, thinking it was earning me more money. It wasn’t. I should have done the math.
- By investing in a Roth 401k instead of a Traditional 401k, I lost over $375,000.
- We found that only 9% of the respondents should actually invest in a Roth 401k—that’s just 60 people out of 635.

 

[aaronc879]

It's not a one-size-fits-all. Traditional is better for some and ROTH is better for some. Which is better is mostly based on tax bracket while working compared to tax bracket in retirement.

 

[badatmath]

If income permits maxing out regular and adding a roth ira seems okay to me. . . . I liked the no RMD for the ira.

 

[Aerides]

This isn't an article, it's fodder for a site selling financial stuff.

 

[GenXguy]

Yep, more nonsense.

 

[Alex The Great]

I never understood the advantage of Roth 401K. But I'm a long time investor into the traditional 401K and into after tax 401K once it became available, with Mega backdoor Roth approach as I've always had too much income for regular Roth contributions.

 

[MarieIG]

This isn't an article, it's fodder for a site selling financial stuff.

Yep, and strangely, I wasn't tempted.

 

[jazz4cash]

Seemed to be a very shallow article. I think most plans allow contributions to both pretax and Roth simultaneously. Having at least a chunk of Roth assets provides flexibility for major expenses, income smoothing, access to contributions pre 59.5, etc. Why choose if you can have both?

 

[RxMan]

My last job had both options. It was the first time I had the option to invest in a Roth 401k. I opted to put some of my contributions into both. I’m glad I did and I will do it again if I have the option in the future. I guess I’m a 9%er.

 

[DrRoy]

Roth works for me. I was not able to get a lot put into it.

 

[jollystomper]

More clickbait. I will pass on it . The decision just seems like a classic "it depends on your situation" choice.
Megacorp did not provide a Roth 401K option until about 18 months before I retired. At that point I did not want to complicate my savings structure any further, and it would not have been much benefit in that time frame. But that is just me .

 

[pb4uski]

Not sure if the below article is hogwash or true so figured I would post it here to find out ... the article rambles a bit and pushes an online calculator which I was not going to do.

https://lifeandmyfinances.com/retirement/roth-401k-calculator

Some quotes:
- I started investing in a Roth ten years ago, thinking it was earning me more money. It wasn’t. I should have done the math.
- By investing in a Roth 401k instead of a Traditional 401k, I lost over $375,000.
- We found that only 9% of the respondents should actually invest in a Roth 401k—that’s just 60 people out of 635.

It's not a one-size-fits-all. Traditional is better for some and ROTH is better for some. Which is better is mostly based on tax bracket while working compared to tax bracket in retirement.

+1

I think it is a fair article. Unlike others that I've seen, while it rambles about too much, it does focus on the difference between the tax savings/effective tax rate when retirement contributions are made vs the taxes paid/effective tax on withdrawals.

It wouldn't surprise me that 90% of people are in a lower tax rate in retirement than they were when working so therefore a Roth is indeed a bad idea for them. That even applies to most people here even though we like to complain the dreaded tax torpedo... the level of taxes on withdrawals is annoying while the taxes saved when that income was deferred is long forgotton.

I was a high income earner and was in the 28% and sometimes 33% marginal tax rate when I was working so saved 28% or 33% or a mix thereof on my tax-deferred contrbutions. On my Roth conversions over the past 10 years have paid an average of 10%. Even after I start SS and RMDs strike me, my effective rate on RMDs will "only" be 16-17%.

Another factor of savings is when I was working I lived in a state with an income tax and now that I'm retired I live in a state with no income tax so additional savings... and if I had gone with a Roth I would have paid a lot more state income tax while working.

So I have saved big time from tax-deferral.. 10% or more for federal income tax alone... meaning that I would have LOST big time if I had used Roth rather than tax-deferred because I would have paid 28% or 33% in advance while working vs 16-17% or less in retirement.

 

[Montecfo]

I did read the article and did not detect anything nefarious. Essentially, if you will be in a higher bracket when doing withdrawals, then Roth makes sense. If you will be in a higher bracket when contributing, traditional makes sense.

Of course, the really tough part is accurately projecting your future tax brackets, which requires knowing your future income needs, law changes, changes in marital status, your own and spouse lifespans, future beneficiaries, their projected earnings and their tax rates, etc. It is very hard to know those things 10, 20 30+ years hence.

My thesis on this is you should want a large favorable difference in tax brackets to address these uncertainties. This improves the chance of a Roth contribution or a conversion paying off and addresses the very long expected timeframe of receiving the payoff.

With a Roth you are making an investment in something called "Lower Future Taxes", call it LFT. Like any investment you want to get the greatest payoff in the least time. So paying in when you are in the 12% bracket and withdrawing at 22% would provide a return of 10/12 or 83%. That is relatively attractive given the uncertainty and the fact your investment horizon is uncertain: it is your remaining lifetime. If that horizon is 20 years, then this amounts to is a little over 2% per year.

Now, if you are paying in at the 22% bracket and expect to withdraw when you are in the 24% bracket, your return is 2/22 or 9%. This is far less compelling obviously and this investment in LFT seems to make little investment sense at less than half a percent per year over a 20 year horizon.

In either case, your annual investment return is higher if the time to payoff is shorter. This may also reduce the uncertainty of the other variables so you can make a better investment decision. This favors late Roth conversions as opposed to early Roth contributions.

Now I think sometimes these calculators can lull us into believing we can precisely figure this out 10, 20 or 30+ years in advance. I tend to doubt that myself for the reasons stated.

And your results may vary.

 

[arcyallen]

I never understood the advantage of Roth 401K.

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.

 

[athena53]

<snip>
Of course, the really tough part is accurately projecting your future tax brackets, which requires knowing your future income needs, law changes, changes in marital status, your own and spouse lifespans, future beneficiaries, their projected earnings and their tax rates, etc. It is very hard to know those things 10, 20 30+ years hence.

<snip>
Now I think sometimes these calculators can lull us into believing we can precisely figure this out 10, 20 or 30+ years in advance. I tend to doubt that myself for the reasons stated.

And your results may vary.

My thoughts exactly. It's a bit of a crap shoot. Who ever heard of IRMAA (which is affected by withdrawals from a traditional IRA) back when Roths were first offered? I'm considering conversion at a rate more like 33% for 2023 if the numbers work out the way I expect. It's partly to save DS and DDIL taxes since they'll most likely inherit a substantial portion of my IRA (I'm 70, it's over $1 million and I have an equal amount in after-tax) and we don't know what the future holds.

 

[qwerty3656]

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.

 

[Koolau]

I never had the option but I got on the Roth band-wagon early. I still look at Roths as having lots of advantages. Combined with your 401(k), I never did the research as it wasn't an option. Didn't read the article, but I might go back just for funzies. YMMV

 

[Out of Steam]

It would be easier to spend retirement funds if we weren't sending 27% in taxes off the top of every dollar we spend above our scheduled withdrawals.

That can be good or bad. Of course, that combined tax rate was at 33% just before my wife retired.

 

[pacergal]

I thought it was informative.
Roth was not an option where I worked, until about 10 years prior to retirement.
Calculators and advisors I have talked to show me that it is not much of a difference for us and my understanding is there are some good tax advantages to IRA for medical/long term care if needed. So we simply have left things alone for now.

 

[GenXguy]

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.

Think you. It seems some people are missing out on that point.

I have both. My tax deferred is much higher, but I can pull from my Roth during the years ahead without affecting my MAGI so that I can get better subsidies on the ACA. It also helps to minimize the taxing of my qualified dividends, which I didn't have nearly as much during most of my working years.

 

[LateToFIRE]

+1

I think it is a fair article. Unlike others that I've seen, while it rambles about too much, it does focus on the difference between the tax savings/effective tax rate when retirement contributions are made vs the taxes paid/effective tax on withdrawals.

It wouldn't surprise me that 90% of people are in a lower tax rate in retirement than they were when working so therefore a Roth is indeed a bad idea for them. That even applies to most people here even though we like to complain the dreaded tax torpedo... the level of taxes on withdrawals is annoying while the taxes saved when that income was deferred is long forgotton.

I was a high income earner and was in the 28% and sometimes 33% marginal tax rate when I was working so saved 28% or 33% or a mix thereof on my tax-deferred contrbutions. On my Roth conversions over the past 10 years have paid an average of 10%. Even after I start SS and RMDs strike me, my effective rate on RMDs will "only" be 16-17%.

Another factor of savings is when I was working I lived in a state with an income tax and now that I'm retired I live in a state with no income tax so additional savings... and if I had gone with a Roth I would have paid a lot more state income tax while working.

So I have saved big time from tax-deferral.. 10% or more for federal income tax alone... meaning that I would have LOST big time if I had used Roth rather than tax-deferred because I would have paid 28% or 33% in advance while working vs 16-17% or less in retirement.

Similarly, I've spent the last 20 years or so in a marginal tax-bracket approaching 50% between Fed/State/Local, so have always used pre-tax t-IRA vs Roth - no brainer decision - tax bracket in retirement will be considerably lower, though maybe not low enough for Roth conversions to make sense (different topic though).

 

[Gumby]

While working, the young wife and I were generally precluded by our income from contributing to a tIRA or a Roth IRA, and neither of us ever had access to a Roth 401k, so we only saved in regular 401k, 457, 403b or taxable accounts. We did manage to start Roth accounts in a year long ago when we were allowed to contribute something like $200. So that started the 5 year clock and has been the home for our Roth conversions since we retired.

To the point of the article, when we were saving in our regular 401k, 457 and 403b accounts, we were avoiding taxes at marginal rates of 33% and above, so we've already won the tax arbitrage when it comes to taking it out. If our income had been lower, we probably wouldn't have contributed to regular 401k etc and would instead have contributed up to the limits in a Roth IRA or Roth 401k (if it had been available).

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.

 

[Texas Proud]

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...

 

[Alex The Great]

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.

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.

 

[pb4uski]

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...

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.