Comparing Investment Accounts: Roth vs. Traditional

One of the best and simplest ways to decide between "Roth" or "Pretax" for 401(k) and IRA contributions is to determine what the tax rate is of the dollar going in, and what it would be coming out. Higher tax rate in than out often is a strong case for deferring taxes. But arithmetic alone really isn't enough. Sometimes drawing a pie chart of the tax treatment of your nest egg's parts can really help - you'll see if you're building a one-legged stool to prop up your retirement. Adding more Roth assets can give you confidence and flexibility to spend more on that once in a lifetime trip early in retirement. That $50K pull doesn't hit so hard when you're not trying to stay under a number for IRMAA, ACA subsidies, etc. Taxable brokerage account investments can be donated in kind for charitable giving. They can be sold often times at a 0% long-term capital gains rate. They're fantastically flexible as an inheritance compared to your IRA. And for the "always only roth" crowd - sometimes IRA and 401k withdrawals can come out tax free! Either as your standard deduction with Roth stacked on top, or as a Qualified Charitable Distribution in your 70s. Buy yourself some future flexibility. Don't just diversify your investments, diversify their tax treatement. *Investing is like cooking. You need the right ingredients AND the right mixture. This pie chart is an illustration and may not reflect your ideal investment "recipe."

I constantly meet people who are choosing to pay 32% today to avoid paying 8-10% later. They don't realize that's what they're doing. But that's exactly what "always do Roth" looks like at higher incomes. Taxes are progressive. During your working years, the Roth vs. traditional decision is about the next dollar. Married, two incomes, making good money, that next dollar is sitting on top of everything else you earned. At 32% marginal, every $1,000 into traditional saves you $320 today. In retirement the math flips. You're not deciding about one more dollar. You're deciding how much to pull out for the year. And your effective rate, what you actually pay across the whole withdrawal, is much lower than people expect. Real example. Married couple, house paid off, spending $120,000 a year from their traditional 401k. First $32,200 comes out tax free (standard deduction). The remaining $87,800 climbs through the brackets: First $23,850 at 10% — $2,385 Next $63,950 at 12% — $7,674 Total federal tax: $10,059 Effective rate: 8.4% They deferred at 32%. They're spending at 8.4% effective. If they had gone Roth, they would have paid $38,400 in taxes on that same $120K while working. Instead they paid $10,059 in retirement. That's $28,000 per year they kept just from sequencing correctly. If they went Roth they would have paid 32% just to avoid 8.4%. Not great Bob. For the "rates will go up" fear to matter, effective retirement rates would need to more than triple. Even a full reversion to pre-TCJA 2017 rates only moves the needle to about 15% for this family. Pick Roth when it makes sense (early career, low income years, conversion windows). The end goal is to get over to Roth for most folks, but the sequencing and timing is far more important than most realize. But "rates will go up" is not a reason to pay 32% today to avoid 8% later.

Should an employee earning $85,000 contribute to a TRADITIONAL or ROTH 401(k)? My take: Traditional should be the default unless they have a compelling argument ("but tax rates will go up" is not one of them). Let's break it down for a single W-2 employee: • Salary: $85,000 • FICA: $6,502.50 • 401(k) Contribution: $17,000 (20%) If they choose Traditional: • Federal Income Tax: $6,409 • Net Take-Home Pay: $55,088.50 If they choose Roth: • Federal Income Tax: $10,149 • Net Take-Home Pay: $51,348.50 Here are the biggest questions most retirement educators are missing: 1. What's happening to the difference in net pay of $3,740 ($17,000 contribution * 22% marginal tax savings)? We can't assume it doesn't exist, or that workers can't have the discipline to save or invest it elsewhere. 2. If this same single taxpayer retired at age 64 without other income sources before Social Security (which is becoming increasingly common with the reduction of pensions), which effective tax rate would be applied to those traditional retirement account distributions to create a net income of $85,000 (their previous FULL salary)? Only 13.3%! They would distribute $98,011 from their traditional IRA in retirement, with the first $15,750 wiped out by the standard deduction. The next $11,925 is taxed at 10%, the next $36,550 is taxed at 12%, and the remaining $33,786 is taxed at 22%. Don't make traditional vs. Roth retirement account decisions at work based on what you anticipate THE future tax rates to be. Make the decision based on your future anticipated sources of taxable income. When you contribute to a traditional (pre-tax) account, your contributions are deferred from taxable income at the marginal tax brackets TOP-DOWN. When you distribute or convert those funds in retirement, they are included in taxable income at the marginal tax brackets BOTTOM-UP. Which future income might fill up those significant deductions and lower marginal tax brackets? #taxplanning #traditionalvsroth #paytaxwhenyoupaylesstax

Hello Connections As promised my weekly post on US accounting & Taxation is as under - The main differences between traditional and Roth retirement account contributions are related to when you pay taxes and when you can withdraw funds without penalties: Traditional Contributions: Contributions are made with pre-tax dollars, lowering your taxable income in the current year. This helps reduce your current year tax bill. Distributions in retirement, including investment earnings, are taxed at your ordinary income tax rate. So you get a tax break now but have to pay taxes later. Most plans have penalties if withdrawing funds before age 59.5, with some exceptions. Roth Contributions: Contributions are made with after-tax dollars, so there's no upfront tax break. This means contributions don't lower your current taxable income. Qualified distributions in retirement, including investment earnings, are tax-free. So you pay taxes now but withdrawals are tax-free later. Contributions can be withdrawn tax and penalty-free at any time. There may still be penalties for early withdrawal of investment earnings. In summary, traditional lets you defer taxes while Roth pays taxes upfront. This impacts when you realize the tax advantages - now for traditional, later for Roth. The overall lifetime tax benefits can depend on your specific situation. Many people choose to use both traditional and Roth accounts. An IRA (Individual Retirement Account) and a 401(k) are both retirement savings accounts that have some key differences: IRA: Individual retirement account you open yourself, independent of an employer. Contribution limits are lower ($6,000 per year for 2024, plus an extra $1,000 if over 50). Can be traditional IRA or Roth IRA. Can withdraw contributions tax and penalty-free anytime. 401(k): Employer-sponsored retirement plan, must be offered by your workplace. Higher contribution limits ($22,500 per year for 2024, plus an extra $7,500 if over 50).Traditional or Roth options. Some employers match contributions. Penalties apply if withdrawing funds before age 59.5, with few exceptions. In summary: 401(k) depends on employer while anyone can open an IRA. 401(k) allows you to save significantly more each year. IRA offers more flexibility on fund options and withdrawals. Many people contribute to both IRAs and 401(k)s to maximize their retirement savings with the benefits of each account.