Regular vs. Roth = No difference

[Chuckanut]

This is an interesting article. It shows that if the post and pre retirement tax brackets are the same, there is no difference between Roth and Regular 401K's.

What's the Tax Advantage of 401(k)s? - Encore - SmartMoney

Problems?? It does not take into account that the Roth has no RMD. And, I wonder about the wisdom of changing capital gains to regular income when it comes to taxing the withdrawals from the regular IRA.

 

[ziggy29]

Yep. Absent distortions like different tax laws, the math for TIRAs and RIRAs works out to be the same assuming a constant tax bracket, thanks to the commutative property of multiplication.

And the RMD factor combined with the transformation of long-term capital gains and dividends in a traditional IRA/401K becoming ordinary income when taxed is what makes folks suggest that when you have both Roth and traditional IRAs and 401Ks, keep the tax-favored gains in the Roth where you can so you don't turn maximum 15% tax rates into 25% or higher rates when you withdraw it.

 

[GrayHare]

Not made clear in the article: they are equal ONLY if a worker contributes more to the traditional 401K than to the Roth 401k. If the worker instead pays from another source the tax due on the Roth 401k contrib, and thus contributes the same amount to the Roth as to the traditional, the Roth comes out ahead over time.

 

[kaneohe]

Not made clear in the article: they are equal ONLY if a worker contributes more to the traditional 401K than to the Roth 401k. If the worker instead pays from another source the tax due on the Roth 401k contrib, and thus contributes the same amount to the Roth as to the traditional, the Roth comes out ahead over time.

agree w/ this.

 

[Chuckanut]

Not made clear in the article: they are equal ONLY if a worker contributes more to the traditional 401K than to the Roth 401k. If the worker instead pays from another source the tax due on the Roth 401k contrib, and thus contributes the same amount to the Roth as to the traditional, the Roth comes out ahead over time.

I understand what you are saying, but then does not the person who pays the tax due on the Roth from another source, suffer an opportunity cost since he/she is out that money and everything it will earn over the life of the Roth?

 

[Mulligan]

One of the reasons, I chose and continue to prefer Roths is state income tax. If I stay in my present state in retirement, I need to stay under 85k a year to snag a pension exemption that would save $2000 a year in taxes. I will project myself to bumping up against in several years. If I withdraw Roth earnings, they do not count on your

 

[Mulligan]

One of the reasons, I chose and continue to prefer Roths is state income tax. If I stay in my present state in retirement, I need to stay under 85k a year to snag a pension exemption that would save $2000 a year in taxes. I will project myself to bumping up against in several years. If I withdraw Roth earnings, they do not count on your

OOpps darn Ipad... Adjusted gross income if I understand it correctly. This could keep me under the limit for several more years since that number is not adjusted for inflation. Someone please tell me if I am wrong!

 

[LOL!]

The only thing folks hate worse than doing math is ... reading about math.

 

[Koolau]

Another couple of advantages of the Roth (even if the math is the same): You can take your original money (not the gains) out at any time w/out penalty. The inheritance rules are more flexible as well IIRC.

As I believe Mulligan alluded to (I'll expand) the Roth allows one to titrate their income to stay within a certain tax bracket. Some tIRA and some Roth money is taxed as if only the tIRA had been withdrawn - thus avoiding (in some situations) pushing one into a higher bracket. Not sure how that works with SS taxability but I'm thinking that is also an advantage - could be wrong.

YMMV

 

[kaneohe]

I understand what you are saying, but then does not the person who pays the tax due on the Roth from another source, suffer an opportunity cost since he/she is out that money and everything it will earn over the life of the Roth?

1) 1000 Roth; 250 side fund; 25% bracket; pay tax w/ side fund;
only have 1000 Roth; Roth doubles or whatever in N yrs; after tax value
is 2000 (assuming no penalties for early withdrawal)
2) 1000 TIRA; 250 side fund; no taxes due;
in N yrs, TIRA doubles to 2000; side fund doubles to 500;
TIRA after tax is 1500; side fund after tax is 500 less CG tax on 250;
total after tax value is 2000 less CG tax on 250

Roth is larger by the CG tax on 250.

numbers speak louder than thoughts..........at some point

 

[Animorph]

I understand what you are saying, but then does not the person who pays the tax due on the Roth from another source, suffer an opportunity cost since he/she is out that money and everything it will earn over the life of the Roth?

The guy with the Roth gets to add that tax money value back into the Roth and it grows tax-free from then on. The Roth shelters more after-tax value than the traditional 401k account.

 

[nun]

I defer the max through 457, 403b and a 401a plans and I end up paying almost the same tax as Mitt, just 16%. I do the ROTH because of the advantages already mentioned and also because it is good for international tax planning, even though I estimate my federal tax rate in retirement will be 10%.

 

[PaddyMac]

The key is "IF" your tax brackets remain the same. We're in the 25% bracket now (would be 28% if did have a Solo 401k) and we expect to be in the 15% bracket when we retire. We like the Roth, but the tax deferred savings makes more sense. The one thing I do prefer about the Roth is that we can spend it in early retirement.

 

[teejayevans]

Another couple of advantages of the Roth (even if the math is the same): You can take your original money (not the gains) out at any time w/out penalty. The inheritance rules are more flexible as well IIRC.

technically it's any time after 5 years...
TJ

 

[ronocnikral]

I've gone through the math here before and shown that Roth has a slight advantage assuming same tax brackets now and in retirement.

My feeling is the gov't likes it b/c they get an "advance" on their tax "revenues." I undoubetly feel they will find some form of tax for roth money within the next 60 years.

 

[FinanceDude]

The more articles I see, the more I am convinced a tax-efficient individual brokerage account is the way to go.

Assuming the same tax rates 20 years into the future is not helpful. After 9/11, our taxes were slashed to the lowest rates since the early 20th century. Anyone who thinks taxes are NOT going to be higher in the future, well, I'd like to hear that Magic 8 ball reasoning............

 

[kaneohe]

technically it's any time after 5 years...
TJ

There is no clock for original contributions. There are 5 yr clocks for conversions (depending on whether taxable or nontaxable) and perhaps an age clock as well.

 

[Animorph]

The more articles I see, the more I am convinced a tax-efficient individual brokerage account is the way to go.

Assuming the same tax rates 20 years into the future is not helpful. After 9/11, our taxes were slashed to the lowest rates since the early 20th century. Anyone who thinks taxes are NOT going to be higher in the future, well, I'd like to hear that Magic 8 ball reasoning............

Maybe income taxes won't go higher. Or maybe you'll be in a "lower" tax bracket in retirement that equals your current "higher" tax bracket. Something like a VAT or sales tax could be implemented. That would hit Roths and traditional IRA's. I doubt the govt could get away with a specific Roth-only tax. But yeah, forecasting tax rates is a challenge.

Rather than a taxable account though, I think a diversity of tax treatments will be valuable. Certainly my retirment planning says a mix of account types will be actively used during retirement.

Seems like a Roth is always going to be better than a taxable account though. Same tax treatment going in, and at least a promise of no taxes coming out.

 

[Chuckanut]

Math does not lie, but it can mislead, if we do not use our common sense and answer the question. Consider this problem: A school bus holds 60 students. 150 students are going on a field trip. How many school buses will be needed. Many young sprouts will do that math and answer 2 1/2 busses. But, common sense tells three busses are needed. Don't confuse the math problem 150 divided by 60 with the question!!!

 

[LOL!]

The more articles I see, the more I am convinced a tax-efficient individual brokerage account is the way to go.

In a strange way that people cannot understand there is a great deal of truth to this.

We do not have Roth 401(k)s, but have traditional 401(k)s which we contribute the maximum to. We have not been eligible for Roth IRAs until relatively recently, so we have small Roth IRA accounts that we contribute the maximum to as well. The Roth IRAs amount to about 3% of our total portfolio, so are not significant sum at all. We also have a joint taxable account invested very tax efficiently.

That joint taxable account will allow us to convert our traditional 401(k)s to Roth IRAs when we leave our jobs. The conversion will occur mostly in the 0% tax bracket. The way I see it, 0% tax is much better than 33% tax.

I can see our situation as unusual, but I do not see it as unique.

 

[Chuckanut]

We also have a joint taxable account invested very tax efficiently.

Good point. All the discussion of IRA's and 401k's sometimes draws attention from our taxable funds. Tax efficient investing can be a real help here.

 

[Hamlet]

Higher for everyone as a group? definately.

Higher for people moving from employment to retirement? Much fuzzier.

An awful lot of retiree's have pretty modest realized incomes in retirement compared to their saving years. If you're in a pretty high tax bracket now, I doubt it will be a huge mistake for most people to fund a 401k.

Of course, if you are in that high tax bracket, it makes sense to be funding the 401k, the Roth, and some after tax savings as well.

The more articles I see, the more I am convinced a tax-efficient individual brokerage account is the way to go.

Assuming the same tax rates 20 years into the future is not helpful. After 9/11, our taxes were slashed to the lowest rates since the early 20th century. Anyone who thinks taxes are NOT going to be higher in the future, well, I'd like to hear that Magic 8 ball reasoning............

 

[Shawn]

That joint taxable account will allow us to convert our traditional 401(k)s to Roth IRAs when we leave our jobs. The conversion will occur mostly in the 0% tax bracket. The way I see it, 0% tax is much better than 33% tax.

I can see our situation as unusual, but I do not see it as unique.

I plan to retire this year at age 52. I'm debating whether I should begin my $60K/yr pension this year or wait until age 60 when it will be $100K/yr (plus COLA between now and then). This decision has a lot of variables/uncertainties such as health insurance. But one factor that favors waiting until age 60 is that I'd have 8 years to convert some of my traditional 401(k) funds to a Roth at a very low, possibly 0%, tax rate. Back of the envelope calculations suggest I could save $100K in taxes by doing this. This is not chump change.

 

[thefinancebuff]

Problems?? It does not take into account that the Roth has no RMD. And, I wonder about the wisdom of changing capital gains to regular income when it comes to taxing the withdrawals from the regular IRA.

For most people without a pension, RMD isn't a problem because they will need to withdraw the money for income anyway. Your changing capital gains to regular income logic ignores the up-front deduction. The tax on withdrawals is making up for the up-front deduction. The capital gains in the traditional 401k is free from taxes. It beats capital gains tax at any rate above 0%.

 

[kaneohe]

For most people without a pension, RMD isn't a problem because they will need to withdraw the money for income anyway. Your changing capital gains to regular income logic ignores the up-front deduction. The tax on withdrawals is making up for the up-front deduction. The capital gains in the traditional 401k is free from taxes. It beats capital gains tax at any rate above 0%.

another good example demonstrating why the real answer is in the numbers and not in intuition, at least until the intuition is trained .............