The Case Against Roth 401(k)

To Roth or not to Roth, that is the question. Like many other employers, my employer also started offering a Roth 401k option in our 401(k) plan.

This question of whether one is better off with contributing to the Traditional 401k or contributing to the Roth 401k has been the subject of a lot of debate. Although there is no one-size-fits-all answer, I think for most people the majority, if not 100%, of the contribution should go to a Traditional 401(k). I will state my case against the Roth 401(k) in this article.

The basic premise of a Roth 401(k), and to some extent a Roth IRA, is that of prepayment. You are prepaying the tax now so you don’t have to pay tax later. This prepayment concept is not uncommon. For example, buying a season ticket is prepaying for the individual events. Buying a timeshare is prepaying for vacation accommodation.

Whenever we deal with a prepayment scheme, we have to assess whether prepaying is “worth it.” The same paradigm also applies to Traditional versus Roth 401(k). There are several factors that make prepaying the taxes now not worth it.

1. Fill in lower tax brackets in retirement

I showed in a previous post Commutative Law of Multiplication that if the marginal tax rate at retirement is the same as it is now, the Traditional and Roth 401(k)’s are equivalent. If the marginal tax rate is higher now than in retirement, one is better off contributing to a Traditional 401k. If the current marginal tax rate is lower, one is better off contributing to a Roth 401k.

But that applies only to the marginal dollar, which is the last dollar you can shift between Traditional and Roth 401(k). It is not necessarily the case for the entire contribution or the average dollar.

The tax system in the United States is progressive and it will probably stay that way. That means that income is taxed at increasing rates as it goes higher. Even if you think the marginal tax rate in the future will be higher, there will still be lower brackets and these lower brackets should be filled with money from a Traditional 401(k).

This chart below illustrates what the tax brackets are in 2008 for a married couple earning $100,000 between the two of them if they file jointly using the standard deduction (click on the chart to see it in full size).

Tax Brackets

The first $17,900 of income is not taxed because it’s taken up by deductions and exemptions. The next $16,050 is taxed at 10%, the next $49,050 at 15%, the next $17,000 at 25%.

Because the way a Traditional 401(k) works, the dollars they contribute come off from the top, in the highest tax bracket for their income. After they retire, the dollars they receive from their Traditional 401(k) pour into an empty or shallow bucket.

Even if we assume their marginal tax bracket in retirement will be higher due to tax increases, a large portion of the 401(k) withdrawal may still be taxed at a lower rate than what it was when they contributed the money.

Until you know you can generate from your Traditional 401(k) enough income to fill the lower brackets, it doesn’t make sense to contribute to a Roth 401(k). For people without a traditional defined benefit pension plan, it means the majority of the retirement savings should go to a Traditional 401(k), not Roth.

If you have a defined benefit pension plan and/or you expect to have a large balance in Traditional 401(k)/IRA, large enough to fill the lower brackets every year, then contributing to Roth makes some sense.

2. Avoid high state income tax

Many people work in high tax states like California and New York today. They work there because there are a lot of well-paying jobs in those states. They won’t necessarily retire there because the high taxes take away a significant portion of their retirement income.

States popular with retirees like Florida and Texas have no state income tax. If you are working in a high tax state today but there is a chance you will retire in a no/low tax state, contributing to a Traditional 401(k) lets you avoid paying the high state income tax on the contributions. Prepaying the high state income tax now is a dead loss.

3. Leave the option open for Roth conversion in the future

When you leave your employer, you can rollover the Traditional 401(k) to a Traditional IRA, which then can be converted to a Roth IRA at a later time when it is advantageous to you . A Roth 401k or IRA on the other hand can never be converted back to Traditional.

With a Traditional 401k, you hold the option, which has value. If you contribute to a Roth, you give up that valuable option. You can decide to convert and pay the tax whenever you are in a lower tax bracket than where you are now. Good times for conversion include:

  • going back to school for a career change;
  • becoming unemployed due to layoffs or burn-out;
  • starting a business (not as much income in the first few years);
  • two-income couple having one parent stay at home or work part-time for a few years after they have kids;
  • a high-income single person marrying a lower-income spouse;
  • taking early retirement;
  • moving from a high tax state to a no/low tax state;

Unless you are sure that your marginal tax bracket will never be lower throughout your career, you should leave the option open by putting money in a Traditional 401(k) and then convert to Roth when an opportunity comes.

4. Avoid triggering phase-outs and AMT

Because contributing to a Roth 401k does not reduce your gross income, you appear to be richer than you otherwise are if you contributed to a Traditional 401k.

There are all kinds of income-based eligibility cutoffs and phase-outs in the tax code. When your exceed the income threshold, your tax benefits from those programs are either reduced or eliminated. Some of these tax breaks include:

  • child tax credit;
  • Hope credit;
  • Lifetime Learning credit;
  • itemized deductions;
  • personal exemptions;
  • eligibility to contribute to a Roth IRA;
  • eligibility to contribute to a Coverdell ESA

Think for example the tax rebate from the 2008 economic stimulus package. If a single person earned $90,000 in 2007 but contributed $10,000 to a Roth 401k, he/she is not eligible for the $600 tax rebate. If he/she contributed $15,000 to a Traditional 401(k) instead, he/she is eligible.

When your income appears to be “too high,” not only do you lose tax benefits, you may even trigger the AMT. Contributing to a Traditional 401(k) will help you qualify for tax benefits and escape or reduce the impact of AMT.

Who Should Use a Roth 401(k)?

With so many disadvantages, then, for whom does a Roth 401(k) make sense?

A Roth 401(k) is good for people in low paying jobs now but expect to have high paying jobs later. Medical doctors in resident programs fit that description very well. They are paid very little while they are in residency but their income is expected to rise substantially higher when they finish the program. Their income will stay high in their career and they will receive a high income after they retire. Prepaying tax now makes sense because they are prepaying at a low rate now and they will avoid paying a higher rate later.

College students working part-time jobs or recent graduates working in entry-level jobs are also good examples for taking advantage of a Roth 401(k) while their income (and their tax rate) is low.

A Roth 401(k) is also good for people who are already in the top tax bracket and expect to be there forever. If they don’t see any chance of being in a lower tax bracket, prepaying tax now will lock in the tax rate so they won’t have to worry about future tax increases.

Tax Diversification?

What about the idea of tax diversification? Some advocate both a Roth 401k and a Traditional 401k because the tax rates in the future are uncertain.

Diversification is good in general but it doesn’t mean automatic 50:50. Just like investing in emerging markets provides diversification, but it doesn’t mean you should invest 50% of your money in emerging markets. You still have to decide how much you should allocate your retirement savings between Traditional and Roth just like you allocate a portfolio between developed markets and emerging markets.

Tax diversification also doesn’t mean you have to do it right now if you are in your peak earning years. There might be better times coming up in the future.

As for me, I’m 100% in a Traditional 401(k). Prepaying tax now is just not worth it.

Higher Effective Contribution Limit

Some say the Roth 401(k) is better because you can effectively contribute more when you are using after-tax money. There is some truth to it. See follow-up post, Roth 401(k) for People Who Contribute the Max, which includes an online spreadsheet that calculates the value of having a higher effective contribution limit in a Roth 401k.

See also: Roth vs Traditional 401K on Bogleheads Forum.

Roth IRA

How does the Roth IRA figure into this?

All arguments for and against the Roth 401k also apply to the Roth IRA when you are not yet contributing the maximum to your traditional 401k. An additional argument in favor of the Roth IRA is that some 401k plans have higher fees. Even then the traditional 401k can still be better when you don’t expect to work there for many years. You can roll over to your own traditional IRA for lower fees when you change jobs. See Alternatives to a High Cost 401k Or 403b Plan.

If you are already contributing the maximum to your traditional 401k, you may still be able to take a deduction for contributing to a traditional IRA. See The Forgotten Deductible Traditional IRA. A Roth IRA is better when you already contribute the maximum to your traditional 401k and you don’t get a deduction for contributing to a traditional IRA anyway.

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  1. Debbie M says

    Interesting. I love the Roths, but I seem I am one of your exceptions. I have a very good pension plan, I’m in the 15% tax bracket, I now live in a state with no state income tax, and I expect my tax rate to go nowhere but up in the future, mostly because I think tax rates will climb, but I also kind of hope to get big raises one day! (See what the tax rates were in the 1970s, and you’ll see what I’m afraid of.)

    Nice analysis.

  2. onthehomefront says

    My company began offering the Roth 401(k) in addition to the traditional 401(k) this year. I stuck with traditional even though I’m just starting out in my career and hope that my income will only go up from here. The deciding factor for me was that the company would not be matching anything in the Roth plan, but would continue it’s current match structure on the Traditional.

    No sense in giving away free money!

    • Ryan Marquette says

      I’d check that with HR. They may still match your Roth contribution but put their bit in as traditional. This can make rollovers a nightmare in the future but I think you still would get your money

  3. Anonymous says

    This is one of the best posts I’ve read in a long time. I *totally* agree.

    I’m paying federal + state marginal rates of about 43%. I fully expect to have less taxable income in retirement, and to live in a lower-tax state. I can see no benefit to putting money into a Roth 401k in this situation.

    It amazes me that alleged financial experts refuse to recognize that for those of us whose retirement income will come entirely from 401k accounts, using a tax-deferred account can result in a tremendous tax savings.

  4. Harry Sit says

    @Debbie – I agree that Roth is perfect for you.

    @onthehomefront – Usually employers don’t penalize you for using Roth. If you contribute to Roth 401k, they will still do the match. It’s just the match is placed in a Traditional 401k account. You will have your money on the Roth side and their match on the Traditional side. If you are just starting your career and you expect higher income (and higher tax rate) down the road, Roth is still good for you.

    @anonymous – Thank you for the compliments. I’m glad you agree with me.

  5. Anonymous says

    I don’t agree with this. Kaye Thomas lays out an extensive comparison between Roth vs Traditional accounts. The bottom line is this:

    The Roth 401(k) is _bigger_ than the traditional 401k. While the nominal contribution limit is the same for both ($15,500), the Roth limit applies to after-tax dollars. This “quirk” of the rules means that while the nominal limits are the same, the Roth is effectively bigger.

  6. Harry Sit says

    With all due respect to Kaye Thomas, the first part of his analysis is not valid because it does not take into account the impact on take-home pay. “Saving in a Roth account can make you as much as 53% wealthier in retirement!” Yeah, right, but you also pay 53% more when you contribute. Until the heading “So the traditional account always loses?” it then starts to make sense.

    Yes Roth lets you effectively save beyond the $15,500 cap on Traditional 401k but people who can afford to do so are also in the high tax brackets. So it comes at a higher cost. Can a single person earning $50,000 gross afford to save $15,500 after tax money in a Roth? Not likely. You need perhaps $100k gross income before you hit the cap. When you are at $100k though, your marginal tax bracket is already pretty high. Read what the 3rd comment said. Is it worth it to pay 43% tax in order to save in a Roth 401k?

  7. Anonymous says

    Roth 401K’s were not available when I was working, so all my deferred dollars are in TIRA/401K’s. My pension puts me just inside the 25% bracket. I ran a projection on what my RMD’s would be starting in 10 years or so and was alarmed at what I’d have to take out by the time I reached 80.
    Over the next 10 years, I am going to convert TIRA $$ to Roth up to the top of the 25% bracket. That will help reduce the RMD problem, but it will still be there.
    I encourage folks to watch this aspect. A mix of TIRA/Roth seems best; unfortunately, I don’t have time to reach the mix I want without forcing myself into the 28% bracket now.


  8. Anonymous says

    Your commutative math law is wrong becuase it doesn’t account for the growth which is taxed on the traditional but not on the Roth. Assume a 40% marginal tax and $100 contribution and 10% growth for 1 year. In the Roth you have $110. In the Traditional you have $110 + 44 (you invested the extra take home pay) = $154. Tax is $44 on the 401(k) and $1.60 on the $4 which leaves you with a net $108.40. Roth wins.

  9. Harry Sit says

    Trust me the math law isn’t wrong. You assumed the tax savings must be invested outside the 401k. Actually you can gross up your 401k contributions to $166.67 and still get the same take home pay (166.67 * 60% = 100). So grow it by 10% you get $183.33. Tax is $183.33 * 40% = $73.33. After paying the tax, you get the same $110.

  10. Anonymous says

    Interesting post, TFB.

    My wife is a teacher and will have a decent pension. I was a federal employee and will have a small pension. The Roth seems to make sense for us, but we are also making contributions to traditional IRA/401ks so that we can take advantage of opportunistic Roth conversions. My wife wants to stay home with our kids for awhile, eventually wants to take a sabbatical. These income-depressing events will be perfect to make Roth conversions more cost-effective.

  11. Anonymous says

    quote: Trust me the math law isn’t wrong. You assumed the tax savings must be invested outside the 401k.

    Well, I’m assuming you are maxing out your 401(k) in either case. I just used $100 to make the math easier.

  12. Anonymous says

    One valuable benefit of the Roth 401(k) is the ability to convert it to a Roth IRA without any tax orcost (once you leave employment). At that point, you can take penalty free withdrawals up to your contributions for any reason at anytime.

  13. Harry Sit says

    @anonymous re: being able to rollover to Roth IRA and do penalty-free withdrawals. It’s true, although not all will agree that being able to raid your retirement account so easily is a valuable benefit. If one really needs money, I think a 401k loan is a better option than taking penalty-free withdrawals because once the money is withdrawn, there is no way to put it back.

  14. Anonymous says

    Are you locked into a one size fits all mentality? It isn’t raiding your retirement account if you are retiring before the government says you are of retirement age.

  15. Don says

    I’m so glad someone else has come to this conclusion. I got a bit of flak over at AllFinancialMatters over a similar analysis.

    I agree with you. There is a lot of jumping on the Roth bandwagon, and there might be good reason to consider the old-fashioned Traditional savings.

  16. mcfnord says

    i track my tax situation very closely. i should hit the 25% rate in September. And that’s when I’ll push every penny to the traditional self-401k. In a future year where I don’t hit the 25% rate, I might convert the traditional funds in to Roth. So traditional acts as a “buffer” to keep me out of the 25% rate, but also soaking up the 15% rate as long as it’s attainable. and there’s an exit strategy, too: i converted $11k a few years ago. after five years I can withdraw it without penalty, such as in a low rate scenario where i can pay down mortgage that’s at a higher rate.

    so traditional wins as an interim to roth when the tax rate is favorable.

  17. 2million 401k says

    Nice piece of work. I didn’t do the math, but decided to stick to the traditional 401k until our tax bracket was lower. The tax deduction was just too significant to miss out on ;-).

  18. Lee says

    Nice analysis, but I’ve spent some time thinking about this and want to call your attention to 2 issues.

    1.) If your tax rate at retirement and now is exactly the same, and you max out your 401K, then Roth vs. Traditional are not equal… you are actually better off with a Roth.

    I know WHY you think they are the same. You are saying that (Tax_rate)*(1+r)^years is the same as (1+r)^years*(Tax rate). On that point I agree, but the two are still not the same.

    The main reason is that both Roth and traditional have the same NOMINAL cap in dollars… $15,500 for 2008. Now which one has the highest cap in POST-TAX dollars? That would be the Roth. You can put $15,500 pretax into a traditional 401K, or, if your tax rate is 50%, then you can put $31,000 of pretax into a Roth. Of course, in a traditional case, you’d still have $15,500 leftover to invest in taxable accounts, but do the math and you won’t come out ahead if your tax is the same.

    2.) On tax diversification, most people have employer matching, and the matching part is always in pretax dollars (so even if you put money in a Roth, your employer matching will look like it is going into a traditional). Therefore, Roth is actually a nice diversification.

    I concede that the prepayment option is the most compelling case for Traditional. I personally could picture myself going unemployed one year in my 40s, moving to Vegas with no state income tax, and converting the whole thing in a fell swoop.

    It might be good to consider though that right now, Bush has cut taxes to near lows in recent history, and you have to wonder whether we foresee income taxes actually being lower in the future. Also, you are a smart person financially, so I suspect you will be quite rich when you reach 59.5, flush with stocks, bonds, real estate, and lots of other sources of passive and portfolio income. You may very well be forced into the top bracket by your retirement, so if you aren’t there now, go ahead and prepay 🙂

  19. Harry Sit says

    Lee – Thank you for your detailed comments. On the first issue of Roth allowing you to shelter more, it’s true, although it only matters if you are hitting the maximum. According to this study by Vanguard, only 10% of people max out their 401k. If you are one of the 10%, then yes, Roth 401k means you can contribute more. For the other 90%, instead of contributing to Roth 401k, they can also increase their Traditional 401k contributions. If you have enough income to contribute $15,500 after tax money to a Roth 401k, it also means your tax rate is high and therefore you are paying high cost for doing so.

    On your second point of having the match in Traditional as tax diversification, I think the match alone is not going to fill in the lower brackets in the future. Like most people in my generation who don’t have a pension, the majority of my retirement income will come from my 401k and IRAs. For a married couple, the combined 401k and IRA contribution limit is $41k a year. Unless their income is really high, how many people still have money for investing in taxable accounts after putting in $41k a year toward their retirement accounts? The marginal tax rate might be higher, but there will still be lower brackets that need to be filled.

  20. Scott says

    I think I am one of those exceptions too,I have a very good pension plan-I’m in the 25% tax bracket-I currently in NJ.I also think rates have no where but to go in the future.

  21. JoeTaxpayer says

    What a great analysis! Glad I found your page. I’ve come to the same conclusion, and been writing about this as well. The defined benefit pension is important to note (which you did). A great plan can replace 75-80% of one’s income at retirement, and could make the Roth more favorable, although with a plan so great, one isn’t likely to save much else.
    Only other issue I need to study further, is the impact of Social Security taxation. I wrote an article on that at
    and need to work to tie it in to the Roth IRA decision. Many variables to consider.
    Disappointed in Kaye at Fairmard, although I think the site is great.

  22. J says

    Even if you were going to go 100% Traditional, it still might be a good idea to make a small one-time contribution to your Roth 401k account as soon as you can. That year will be the start of the 5-year requirement for qualified distribution eligibility for that Roth 401k account (this is helpful, should you change your mind and elect to fund it in the future).

  23. RK says

    Thank you for writing this. The government is pushing Roth 401(k)’s so that they can receive your tax dollars today instead of tomorrow! The regular 401(k) makes the majority of investors.

  24. steve says

    I need written info stating that a roth ira withdrawl does not factor in to the req min distribution calculations for my traditional ira in the same tax year. These withdrawals will be after the age of 70 1/2. I’ve searched for hours. Thanks

  25. Harry Sit says

    Steve – This article is about Roth 401k, which is still subject to Required Minimum Distributions (RMD). You are asking about Roth IRA. Here are the FAQs on RMD from the IRS. You will see that (a) the RMD rules do not apply to Roth IRAs while the owner is alive; and (b) the RMD from your traditional IRA can only be satisfied by following the rules, i.e. taking the distribution from your traditional IRA. Taking money from elsewhere won’t cut it.

  26. ChimRichalds says

    I think one person addressed this above but you are all forgetting about the GROWTH of the principal over the years. I am 23 and if the funds I contribute to a Roth 401k are in the market for the next 37 years, I am not going to have to pay tax on either the principal OR earnings. If I contribute $2k this year to the Roth 401k, and I’m in the 15% marg. bracket, I am forgoing $300 in tax savings now. GLADLY! Say the $2k invested today is $10k when I’m 59.5, I have only paid $300 in taxes total, whereas a traditional 401k person would be paying taxes on both the contributions and earnings when he/she is 59.5 which is, no matter how you take distributions, way more tax overall than for a Roth 401k.

    Also a great point was raised that the marginal tax rates today are some of the lowest we will ever see! Pay the tax now, max out to ROTH.

  27. Harry Sit says

    Chim – I said “Roth 401(k) is good for people in low paying jobs now but expect to have high paying jobs later.” If you fit that profile, Roth 401(k) is good for you. No I did not forget about the GROWTH. If you are going to stay in 15% tax bracket forever, your $300 tax paid today, if allowed to stay in a traditional 401(k) will grow to a size which will exactly pay for the tax on distribution.

  28. Shawn says

    Excellent article. My employer just added a Roth 401, so I’ve been thinking about this issue over the last several weeks. I’ve been trying to quantify various options under multiple scenarios. For me, the Roth is the likely winner. One cannot overlook the advantage a Roth has for those who maximize their 401 contributions and have defined benefit pensions. This includes higher income people. I calculate that my tax rate in retirement would need to be about 5% lower than my working years to make the traditional 401 a better choice (since I maximize contributions – a very significant effect). My current marginal tax rate is 34.7% (28% federal + 9.3% state – 2.6% federal deduction for state taxes). If I don’t move, under current tax laws and planned retirement dates, my marginal tax rate will be 32% when I retire (25% federal + 9.3% state – 2.3% federal deduction for state taxes). Admittedly, I need to closely monitor my income (close to 33% federal rate, AMT, etc) and weigh the likelihood that I will retire to a low tax state, but for now I’m betting on the Roth.

  29. Srini says


    I love this article about why not to invest in Roth 401K. It covered every topic exactly it should. Excellent article!!! Thanks a lot. I agree 100% with every thing you mentioned and its good to read it in formal writing..

    I contributed 15K in Roth 401K on the pretext of tax diversification. But I am not too comfortable with that logic.. (For all the reasons you listed against Roth). I mean Marginal tax rate vs Effective tax rate even in taxes go high in 20 years form now..

    Any way, I was hit by AMT (lost $1000) because of stupid Roth 401K. Then I Google –> 401K “Roth 401K” AMT

    The first hit I got was your article and its excellent.

    I immediately changed my 2009 contributions from Roth 401K to traditional 401K

  30. J says

    TFB: your work is great, both here and on the bogleheads site.

    I’m in the 28% bracket now and use 401k contributions to bring myself down almost to the 15% bracket. I expect to straddle the 15 and 25% brackets when I retire. So for me, a traditional 401k makes much sense.

    However, I haven’t factored in the social security taxation that Joe Taxpayer talks about in the earlier comments. Granted, tax changes will occur between now and 25+ years from now when I retire. But have you considered a post on your SS tax thoughts?

  31. Harry Sit says

    J – To be honest I haven’t looked into issues related to SS taxation because I’m so far away from receiving SS. I’m not familiar with the rules. I vaguely know there is a 50% zone, a 85% zone, and some offsets for earnings while receiving SS — I’m not sure if those are still the current rules. Too complicated. Guessing future tax rates is hard enough. Congress can always invent new rules. For example they can count Roth withdrawal when determining SS payouts or taxation. Roth withdrawal itself is not taxed, but it can be part of means-testing for offsetting other benefits. Too many variations, beyond what my brain cells can handle.

  32. JG says

    TFB, Excellent article! It gets to the real meat of the issue as opposed to many other articles that only cover the shallow points of this ROTH vs. Traditional issue.

    I just wanted to add that another advantage of the Traditional IRA/401k over ROTH exists for those of us applying for finantial aid for school for our children. The Traditional IRA/401k option makes one more aid-eligible by lowering your taxable income.

  33. sls says

    Great article

    I have a related question re Roth conversion. If you have both a deductible and a nondeductible IRA and want to avoid having to convert the deductible portion, can you roll the deductible IRA into a traditional 401(k)? Then you could convert the nondeductible IRA alone.

  34. Harry Sit says

    @sls – Yes, you can roll it into a traditional 401(k). Make sure you complete the rollover before the end of 2009.

  35. JBA says

    I know that the issue is traditional 401K vs. Roth 401K… but what I was wondering what if you max your traditional and then additionally (assuming you meet income limitations) open an Roth IRA.

    Just to try to maintain some tax diversification…

  36. Harry Sit says

    JBA – Roth IRA is totally fine because it doesn’t take away the contribution limit for traditional 401k.

  37. BR says

    Great, insightful article. I have pondered this since my employer made Roth 401k available in 2007. Living in NY, my marginal tax rate is ~36%. Totally doesn’t make sense doing Roth because from a financial standpoint a) it could trigger a higher current marginal tax rate +AMT, b) at retirement, moving out of NY to a tax-free state provides around a 6% tax hedge, which when combined with a potentially lower bracket at withdrawal time provides a good cushion against overall higher tax rates in the future.

    Admittedly, I am late to this article, but thanks TFB for the good work and your conviction in the responses.

  38. Scott says

    The problem now is I think this whole “Great recession” has changed things,uncle Sam had HUGE bills coming due in terms of it’s debt, but now with hundreds & hundreds of billions in bailout money on top of that,added to the’s now ENORMOUS future debt levels.

    You can say well they will raise the taxes on the rich only( those families making more than 200K if you wanna call them rich)but I think this whole big thing about raising taxes on the over 200K is just to get use use to it.There is just not enough rich people to make serious dent in the HUGE debt,taxes will have to be raised on everyone at some point…and I think it will be not so far in the distant future.

    Uncle Sam has some serious debt issues 5,10,15 and years beyond down the line,and defered taxes..401ks retirement money etc.adds up to trillions still owed to the goverment,one quick swipe of the pen by the goverment raising income taxes on everyone and the goverment just gave themselves an extra $500 billion
    from defered 401ks and IRAs.

    I have to think this whole recession changed the game..How many zero’s can you add to a debt in short period and not have it choke you at some point..Medicare will be first HUGE debt in 10 years that will come due when it runs out of money,thats just the beginning though..

  39. Wes says

    “The Roth 401(k) is _bigger_ than the traditional 401k. While the nominal contribution limit is the same for both ($15,500), the Roth limit applies to after-tax dollars. This “quirk” of the rules means that while the nominal limits are the same, the Roth is effectively bigger.”

    Could someone explain this to me?? I’m just a novice, sorry!

  40. J says

    Wes – It’s another way of saying that you pay for taxes in a Roth up front.

    If you put 15.5k in a Roth you take 15.5k out later. With a traditional 401k, you put 15.5k in, you get 15.5k minus the taxes at your income future tax rate.

    I think what Scott is missing is that new taxes could come in many forms. They could come from reduced services (you have to pay for stuff yourself), pay-for-service (billing for trash service), to outside an income tax like a VAT tax.

    Or it could be that future revenue will bring taxes down. I remember the cries that Reagan’s crazy budget deficits and tax cuts would result in higher taxes for the next generation. Taxes were generally lower 10 years later. Politics aside, as TFB says above it is impossible to judge future income tax rates.

    I hedge my bets and use traditional until I hit the 15% bracket, then I use Roth.

  41. Donald says

    What I have not seen, and perhaps I just missed it, is a discussion regarding the effect one’s asset allocation has on the decision. If one is investing in mostly bonds then I think one can consider the points raised in this article when comparing the two. Equity investments raise other tax issues. Withdrawals from a traditional 401K are taxed as ordinary income. For someone with a large equity stake it makes little since to invest that money in a traditional 401K when you can invest it outside of the 401K and be subject to the much lower capital gains rate upon sale. (Of course this assumes a tax efficient stock investment like a total market index fund). A Roth 401K is even better because you are paying no tax on the withdrawal of an asset class that historically performed better than fixed income investments. Unless you are going to be in a significantly lower tax bracket (like dropping from 35% to 15%) I fail to see why it is ever good to put tax efficient equities in a traditional 401K. Leave that room for inefficient investment vehicles like bonds and REITs.

    Just as an aside, I have noticed that several people have advanced the opinion that one can’t max out their 401(k) unless they are already in a high tax bracket making over a 100K a year. This is simply false. I max out my TSP (the government and military version of a 401(k)) and max out my Roth IRA- all on an enlisted military members salary.

  42. Harry Sit says

    @Donald – Strictly between a traditional 401(k) and a Roth 401(k), asset allocation has nothing to do with them, because the lower capital gains tax rate only applies to taxable accounts. Between a traditional 401(k) and a taxable account, giving up the tax deduction in order to invest in stocks in a taxable account almost never pays. You can play with the spreadsheet in Alternatives to a High Cost 401k Or 403b Plan and see for yourself.

    Whether to contribute to a 401k, which version you use, and what you put into the account after you contribute are totally separate issues.

    Kudos to you for your high savings rate. If only all Americans save as much you do!

  43. Donald says

    I guess an assumption I missed was that you are assuming if you are saving in a Roth vehicle you are reducing your contribution by whatever tax saving you are losing. I guess I never think like that. I’ll set a goal of saving, for example $20,000 a year, and allocate based on what I think will give me the best tax treatment in the end. I save that amount no matter whether I paid taxes or not, effectively giving me a higher savings rate if I save in a Roth.

    Of course, I am in that small majority that a Roth makes since for because I will end up in a much I higher tax bracket (active duty Navy in medical school.)

  44. PatentGuy says


    I am pleased to have found your blog and in particular this post. Although it is 1.5 years old, there are recent comments, so I am hoping you and/or others will respond to mine. The Roth conversion hype in the WSJ, etc, had me assuming it must be a no-brainer, but upon reading your post and this thread of comments, maybe it is a “brainer”?

    We make a good living and taxes are by far our biggest expense. I agree with you that it is impossible to predict future tax rates, but easy to be assume that the federal and state governments will not be any less “broke” and thus likely will be doing everything they can to take wealth from anyone, anywhere they can find it in order to continue to hand out benefits and (most important) pay interest on the staggering debt, assuming we don’t pull an Argentina on China.

    I would love to get your opinion on whether we are the “exception” to your rule, and should pay the taxes in 2010 to convert an IRA to Roth.

    I am 48; wife is 50. I have a traditional (pre-tax) IRA that has a current balance of around $500K. The IRA was funded entirely from rollovers from former 401k plans, plus a rollover from a cash balance (defined benefits) pension plan from a previous partnership. Since all three rollovers were entirely “before tax” money, we will get hit for income tax on the entire IRA, when distributed. I also have a current “traditional” (before tax) 401k that receives my personal contributions ($16.5K this year), plus my partnership profit sharing plan contributions (about $30K this year). We also have a cash balance (i.e., defined benefits) pension plan into which I contribute approx $50K a year into, all before tax. My wife (school teacher) has both a 403(b) plan and a 457 plan, and we max them out each year ($22K per plan, because she turned 50), again all before tax. We have no IRAs funded by after tax contributions. We have no Roth IRAs and no Roth 401ks.

    For better and worse, we live in California. Since I am self-employed in a partnership, excluding unlimited SE taxes (Medicare), my incremental net tax rate is over 42% (we pay the extra 1% “Rob Reiner” tax at the margin). I don’t know how long we will keep working, but presumably at least another 10 years, and I am more likely to have a transitional retirement over many years, than an abrupt one. We will likely have enough pre-tax 401K and CB plan distributions (if we live long enough) to stay in a relatively high incremental tax bracket at the time the IRA distributions commence. This being the case, I presume that our eventual IRA distributions will be taxed at the highest marginal fed and state rates at the time. Tax rates always matter at the margins, and the “other brackets” you remind people about will already filled by our other income sources. It is possible (likely) we will move out of California to a low or no income tax state before any distributions are made from the IRA (and everything else), but I don’t know with any certainty whether this will happen.

    If I understand correctly, we can “convert” the entire IRA to a Roth IRA by paying tax on the full $500K in 2010 (or split between 2010 and 2011). Assuming tax rates are the same for 2010 as they are for 2009, the conversion would cost us about $210K, and we would use existing (already-taxed) savings to pay the tax.

    So, the question we are faced with is whether to pay the fed/CA state $210K next year to convert the IRA to Roth, or invest the $210k in something else. For simplification, I assume we would make identically-faring investments with the $210K as we do in the IRA account, and the exact same investments in the IRA account, regardless of whether we convert to Roth. To make the math easy, I assume we will withdraw all funds from the IRA at a point in the future when its value has exactly tripled (and that there are no age or other penalties involved by then). Same with the $210K alternative investment.

    Option 1: do the Roth conversion and pay $210K tax in 2010. Result: $1500K “tax free” IRA balance at the time of distribution, no matter where we live.

    Option 2: leave as “traditional” before tax IRA, and invest the $210K in same investments. Result: $1500K fully taxable IRA at time of distribution + $210K already taxed principle + $420K taxable gain on the investment = $1920K taxable plus $210K “tax free”. So, to break even or do better than the Roth conversion option 1, we would need to net at least [$1500K – $210K =] $1290K after tax from the $1920K taxable amount. This translates to an effective combined fed/state net marginal tax rate of no more than [(1920-1290)/1920] = 32.8% at the time of the distribution.

    This may be possible IF we move to a low/no income tax state, but is extremely unlikely if we stay in California. One of your above commentators pointed out that capital gains taxes outside of the IRA are currently lower than income tax rates, it is entirely possible we will pay less than 32.8% on the $420K investment gains in option 2. Again, will depend on what state we live in. Plus, these investment gains are less than 25% of the total taxable amount.

    Did I do the math wrong or make a flawed assumption? I believe your counseling that doing a Roth conversion is a bad idea is premised upon an assumption that people will not have any other significant sources of retirement income outside of the IRA/401k distributions in question. Maybe that is what you meant by the “millionaire” exception??

    Speak to me, my friend. Is this a brainer or a no brainer? It seems to me the answer may come down to where you will live at the time of the distribution!

    Extra credit: Estate planning nuances. Does it help or hurt your heirs if you die with undistributed traditional v. undistributed Roth accounts?

  45. Harry Sit says

    PatentGuy – I think you fit the 2nd exception very well. I wrote in the post:

    “A Roth 401(k) is also good for people who are already in the top tax bracket and expect to be there forever. If they don’t see any chance of being in a lower tax bracket, prepaying tax now will lock in the tax rate so they won’t have to worry about future tax increases.”

    By the way the options for paying the tax on Roth conversion (a) 100% of the conversion income reported as 2010 income OR (b) 50% of the conversion income reported as 2011 income and the other 50% reported as 2012 income. Given that the administration already proposed higher tax rates for your income level in 2011, you probably want to report the whole thing in 2010 and not risk a higher rate in 2011 and 2012.

    For the extra credit, Kaye Thomas at Fairmark wrote:

    “If you have enough wealth to be concerned about the estate tax, you should consider the benefit of a Roth IRA conversion in this connection. The estate tax applies to your total assets at death, including assets held in a traditional IRA or a Roth IRA. The difference is that the estate tax doesn’t “notice” that the Roth IRA is bigger. So the amount of estate tax on a $500,000 IRA is the same whether it’s a traditional IRA or a Roth IRA.”

    Advantages of Conversion

  46. PatentGuy says

    Thanks for the sanity check, TFG.

    I suppose it is still gambling to pay the taxes next year, because we don’t know for sure we are going to stay in a high tax bracket and/or in a high tax state. But at least one of those two is likely. And, if we pay the tax in 2010 (you are correct, we won’t wait for the higher taxes in 2011 and 2012 to make the payments), but things later go south for us financially, the money we “squandered” (in hindsight) on paying the conversion taxes would likely be toast in any event.

  47. Harry Sit says

    PatentGuy – That’s true. If you don’t know whether you will be in a high tax bracket or in a high tax state forever, nobody else knows. Just remember it’s not all or nothing. You can convert only a portion of your traditional IRA as well.

  48. MsTexas says

    I have read all of the posts but am still a little confused. I think the Roth 401k is best for me but I wanted to verify this as I just started a new job and get to make the election now.

    I live in TX – no state income taxes. I will be in the top income tax bracket (Fed). I will max out my 401K contributions. I will receive some sort of match from my company up to a limit. I know that I won’t retire anywhere with cheaper state tax than now since, as I mentioned, TX doesn’t have state income taxes. So, in the future, my state income tax will either remain the same or go dramatically up. Also, I plan on investing 100% of the 401k in growth funds for most of the life of the 401k – hoping for solid gains.

    I don’t know if I will continue to bring in income after retirement. I can easily visualize it going either way…full retirement or self employed.

    Did you think the Roth 401k is right for me?

    Thank you.

  49. ROTH fan says

    Please help me understand if I am missing something here….but there seems to be a huge error in one of the main assumptions in this discussion. If the taxes saved by investing in a non-Roth are allowed to accumulate and compound, they will be significantly inadequate to equal the Roth. Please consider this simplified example:

    If you are in a 30% combined tax bracket (now and in the future) and invest $15,000 in a Roth, you’ll pay a $4,500 tax up front. If you successfully invest the $15,000 for 30 years at 10% compounded, you’ll have $261,741.

    You would also have the same balance in a non-Roth account but would owe $78,522 (30%) in taxes. The argument has been that you can invest the $4,500 in up-front tax savings to cover the future taxes. Unfortunately, the $4,500 will be invested in taxable investments where your 10% return is reduced to 7% and will accumulate in 30 years to only $34,255 which is $44,267 short of the taxes owed.

    I realize that this is simplified example and there are infinite variables, but am I missing something? Thanks.

  50. wx27 says

    Nice write-up on the Roth 401(k). I’ve had discussions with co-workers highlighting what I think is a major point missed by a lot of the analysis out there, that being tax saved by going with a traditional 401(k) comes from the top of the progressive tax/income chart while withdrawals fill up from the bottom. For those of us that won’t have pension income, this makes the appropriate rate comparison today’s marginal vs retirement’s average rate. Other factors favorable to traditional include currently earning in a high state/local tax locale and retiring elsewhere and also that some states allow for an exclusion of a certain amount of pension/IRA income in retirement from state/local taxation (ex: [email protected]). This increases the 0% tax base on your chart, driving the average rate on the whole distribution even lower.
    Also underappreciated is the option you have to convert to Roth in the future when tax rates are favorable to you due to any of the circumstances you outlined.

  51. Scott says

    If I contribute to a ROTH IRA, I know I need to file my taxes married jointly, that is why I stopped contributing (this was a painful and expensive mistake).

    Is this the same for a ROTH 401K? Can I file my taxes any way I want (preferably married but file seperatly)?

  52. Mike says

    Does anyone actually have a list of companies that offer Roth 401ks? I’m about to graduate with a Civil Engineering degree and would love to know which firms offer them.

  53. Ms Texas says

    Finance Buff – what are your thoughts about my post regarding the pros/cons of the Roth when living in a state with no income taxes such as Texas?

  54. Harry Sit says

    Ms Texas – Living in Texas removes one reason against a Roth 401k (#2 in the post). All the other reasons still apply. The key factors are whether you will have a pension when you retire and whether you will retire early. Nobody can predict the future. You just have to take your best shot and live with it.

  55. Ren says

    I think there is another side to the AMT coin and how it impacts the comparison of Traditional and Roth 401k, though I may be mistaken.

    If you are already being hit by AMT then it creates a window of income that has a marginal rate of 28% rather than the 33% (or higher) without AMT. In this situation, any extra income that can be shifted to that year is only taxed at 28% — up to the amount which pushes the regular tax due up to the AMT tax due.

    Of course, the real trouble with this is that I’ve found it exceedingly difficult to estimate in advance the amount of AMT that will be due, particularly with income levels in the range that trigger the deduction and exemption phase-outs. Additionally, there are often better ways of shifting income from the following year rather than from retirement years.

    One final point, unrelated to the rest of my comment and only vaguely related to your post: The newly available ability to convert from traditional to Roth IRAs without income restrictions is a definite boon for those of us without a large existing IRA balance to make non-deductible IRA contributions and then convert them to Roth IRAs. Since the contributions have already been taxed, the tax is only due on the gains.

  56. Harry Sit says

    Ren – Unless you are talking about really high income, the 28% rate is actually more likely 35%. See my previous post about AMT brackets.

    With regard to your final point about Roth conversion, I just did it after rolling over the pre-tax money in the traditional IRA to a 401k plan. See previous post Rollover IRA to Solo 401k.

  57. Ren says

    Hmm.. I must have missed the AMT exemption phase-out. I could have sworn that when I did my taxes last year (TurboTax), adding a $100 of income after AMT was triggered only increased my taxes by $28 (as long as AMT still applied). I was certainly mindful of the standard exemption and deduction phase-outs, as I mentioned.

    Perhaps the AMT exemption phase-out is obscured by the standard phase-outs that may be occurring at similar income levels.

    In any event, I’m glad that I never made the jump to the Roth 401k.

  58. PatentGuy says

    Tax rates will be as high as possible as time goes on. We love our entitlements and God-given benefits for free. There will be more old people that do not work but get lots of entitlements and benefits. In their minds, they earned every penny and then some. But, there will be less young people who actually have good paying jobs (high tax payers) to pay for the old people.

    This would seem to make the case for converting to Roth now, and paying tax now at the GW Fed rate (2010), sla you are young enough and anticipate accumulating a big amount of “tax free” earnings by the time you are old and ready to tap into said earnings.

    BUT, the government of the future can/will simply change the rules and tax you anyway on those earnings. There are many ways to tax you without calling it a direct tax, such as by taxing any other income or SS benefits you may have at an extreme rate. You will be demonized for getting these “tax free” earnings unfairly. if you accumulate wealth, by definition, it was unfair of you to do so. time to “give back to the community” which you have robbed blind by paying taxes to convert your IRA to Roth back in 2010.

    It is year 2035. The U.S., top to bottom, is broke. They will need every penny they can get from you. They are not going to cut-off any entitlements just so you can get the benefit of some “loop hole deal for the rich” back in 2010.

    Mark my words. (Go ahead, mark them. Use a highlighter pen or something like that).

  59. bud says

    very nice article. my company just introduced roth to us as well. As for myself, this is all new to me and maybe someone can advise suggestions to give me a general idea of what is best for me. I’m 25 years old and I plan to attend college in the next 4 months. I plan to stay with the company and hopefully move up as i finish my education, but like i mentioned, all this is new to me and maybe someone can point me in the right direction. Thanks in advance.

  60. Chappy says

    Well done analysis which has helped me reconsider my planning. Two questions: 1) Doesn’t the time value of money alter the equation (i.e. isn’t a dollar in taxes saved today worth more than taxes saved later because the latter’s present value will be less (assuming typical inflation, returns, etc.)?
    2) I heard there’s an option to convert traditional 401k money to Roth 401k in 2010, much like the IRA situation, but I can find nothing to confirm this rumor online. Is it true?

  61. Chappy says

    One more question: On second thought, the above analysis seems to ignore the gains in the account, unless I’m missing something. For the regular 401k, taxes on the income & gains are deferred. In the Roth 401k (after the 5 year period) there’s no tax on withdrawals, so if returns turned out to be fantastically huge (just go with me on this), wouldn’t the Roth come out ahead, since the tax would be zero and the traditional would be large (fantastically huge times any tax rate = large)? Appreciate any thoughts. Thanks!

  62. wx27 says

    Hi Chappy,
    If you assume your effective tax rate on traditional 401k withdrawals is the same as the effective tax rate you pay now while contributing to the Roth 401k, then the two accounts are worth exactly the same IF you can store the taxes you aren’t paying right now with the trad 401k inside a tax-deferred acount.
    Trad starts with $X, grows to X * (1+r), taxes are t * X * (1+r), you are left with X * (1+r) * (1-t) after taxes.
    Roth starts with $X * (1-t), grows to X * (1-t) * (1+r), withdrawn with no further taxes.
    Now since usually the deferred taxes on the trad 401k can’t all be stored in another tax-deferred account, you end up with some tax slippage on that money over time and the Roth comes out slightly ahead.
    Note that all this is assuming effective tax rates are equal across time.

  63. Fred says


    So I can maximize my 401k and my Roth IRA AND have some for taxable investments.

    Should I do Roth 401k or Traditional?

    Seems absolutely braindead obvious to do Roth 401k.

  64. Josue says


    I just finished college and started working a couple weeks ago. I’m single for the momment and my salary is around 70k… I believe that because I just started working full time, Roth might be the way to go. What would you advise me?

  65. CHUCK COURTOT says

    I have 145k in a rollover IRA. I am 60 years old, live in Florida and plan to remove the funds in 2 1/2 years. Would I benefit more by moving the monies to a Roth now, MINUS enough to pay the income tax, or leave things where they are?
    Thank you

  66. Ron says

    How do the taxes work if you leave the country and become a citizen of another country? Everyone talks how bad it may become, but what if you just move to another county (rather than state) and become a citizen? Then you pay taxes at their rate?
    How does that change the taxes paid on a 401K or Roth 401K?

  67. Will says

    TFB – You know your stuff. Thanks.

    I have lots of kids (7) and they use up lots of expenses (college) and I have received plenty of deductions and credits over the years. I have had an effective total federal tax rate of between 0 and 5% over the years. The kids are leaving and taking their deductions with them. The Roth has seemed to make more sense because I am expecting to have more income and less deductions when I retire.

    I converted my present and future 401K contributions to a Roth 401K. I asked my employer if I could convert the historic contributions over to a Roth 401k and pay the taxes now. They said the government didn’t allow it. Is that true?

  68. Harry Sit says

    Will – It is true. You will have to wait until you change jobs and rollover your traditional 401k to a Roth IRA if it still makes sense to do so at that time.

  69. Frank says

    How about paying the tax now, putting your money in an Index UL, where you:

    1. Have no negative returns(401k & IRA are usually 100% in the market)

    2. Lock in your gains every year(this money is never subject to being lost!!) This in itself crushes any Roth. Avg S&P 500 for the last 30 years is something around 8%. Sounds pretty good, but the actual dollar amount your money would have grown in that time is less than 2%. It’s funny the way the 8% number looks good, but real growth is what should be calculated. You’d have been better not worrying about your money and putting it into a CD, unless the bank goes out of business(lol)

    3. Money comes out tax free and is passed to heirs tax free. Over 70% of annuities get passed down to heirs fully taxable.

    I can’t find anything out there on the market that beats this….and don’t tell me the cost of insurance is an issue since we have no idea how much our 401k’s cost every year.(see 60 minutes video about “401k –The Truth Behind Hidden Fees”)

    Just my feedback at what I have found, while trying to research the best way to make sure my retirement will work. It seems that it’s not working for most people in their 70’s and 80’s and I’m 35.

  70. Harry Sit says

    Frank – You sound like an insurance agent muddying the water. If you are serious about buying an IUL, go ahead. It’s your money. Do whatever you want. Contribute to your agent’s retirement. Your agent will thank you.

  71. Osho says

    There is a fundamental gap is all these discussions that is never addressed. Could someone throw light on this please?

    If you contribute say $10,000 to a 401k or a Roth 401 for 30 years, your principal contributed will be $300,000. Add gains of say $100,000 over the 30 years.

    At withdrawal, you are looking at $400,000 in withdrawals.
    Wouldn’t such a high amount put you in the highest tax bracket anyway?
    In that case, doesn’t that make Roth the winner?

    My point is that, just the act of contributing a decent amount every year increase the likelihood that you will be in a high tax bracket when you withdraw BECAUSE you contributed all these years.

  72. Harry Sit says

    Osho – Is there a reason this person wants to withdraw the lifetime savings all at once? Typically a retiree rolls over the 401k plan distribution to an IRA and withdraws only enough to meet income needs once a year.

  73. Osho says

    Thank You. That makes me change my perception. Traditional 401k wins.
    Time will tell of course.
    Never try to optimize finances. You can never win all the time.

  74. Jeremy says

    Hey I was hoping I could get some help as well. I just started working and am only 22 years old. As per advice of my parents, I believe I’m going to start investing the maximum amount into my 401k, and feel like I’ll be able to just get by with doing so.

    So a few points the article lists:
    1) I live in California but definitely plan on moving back to Texas later in my life – Traditional check
    2) I am an entry level worker and am definitely planning on making a lot more in my future (hopefully around $130k+) – this isn’t as gross an increase as say…a doctor, so I’m not sure if traditional or Roth would be more beneficial.
    3) I do plan on contributing the max, or very close to the max starting now…and at 22 years old, I feel Roth is best for this.

    Can anyone here possibly give me some advice for this?


  75. Harry Sit says

    Jeremy – Two out of three ain’t bad. It seems Roth is better for you now. When you make more, you can start doing Traditional.

  76. Perry says

    Great post and very insightful. I’m starting a new job soon and my employer offers both a traditional 401k and a Roth as well. Unfortunately, I’m bad at making concrete decisions despite the information given to me, so I was wondering if you can suggest what might be ideal for me.

    I’m 27, single, live in Texas (no state income tax), and currently make just slightly under 50k. I probably won’t get married or have children for another 5 years. I work in a field that has excellent salary growth, and can expect to make close to 100k within 10 years, and max at around 120k late career. These numbers are not adjusted for inflation of course.

    I can live frugally if need be (at least for the time being), and hope to max out my 401k contribution every year. My employer matches $2 for every $1 I contribute for the first $250, and then matches $1 for every $1 I contribute up to 5% of my eligible contribution (not totally sure what this even means?).

    I plan to stay and retire in Texas.

    Should I opt for a traditional or Roth 401k?

  77. nets1986 says

    TFB – I opened a traditional 401k in January 09 and a Roth 401k in January 10. I have about 15k in the traditional and 5k in the roth now. What is your advice about having a roth and traditional 401k at the same time? Does it hurt me at all in the long run to be splitting my money between the two with compounding interest or anything like that?


  78. Joel K. Berry says

    Would you please send this article to my E-Mail address. For years I have been trying to explain to people that the Roth does not make sense for most people. I was a financial planner for about 8 years and tried to explain that statistics show that 90% of the population will not save enough for retirement, and they should use a deductable (or regular) IRA or 410K and increase thier contribution with the tax savings. Also current tax laws allow for 2 exemptions at 65 and older, so more of your earnings are pre-tax in retirement. Even for younger workers who THINK thier income will increase in the future, everything doesn’t always work out as planed. Just ask the 1 out of 10 people who are unemployed today. A bird in the hand is worth two in the bush every time!

  79. dupree says

    a great article! TFB, appreciate that you take the time to educate us on the subject. i had doubts about roth 401k vs. traditional 401k. my annual taxable gross is >190k. always max out my 401k contributions. my company offered roth 401k. last year. i hv been pondering on whether to split my contributions 1/2 traditional and 1/2 roth. after reading your article in detail and going through all the posts here … for me, at least 100% traditional is the way to go.

  80. Ray says

    A good article however you are making a comparison of a tax system now for the ROTH to what you beleive it will be in the future for the Traditional. If you are close to retirement these predictions of the future tax conditions may hold true however for people in there 20’s and 30’s I believe the tax code will change significantly over time and the result will be tremendously higher taxes in the future. There is little chance that tax brackets of today will look anything like the system in 30 plus years. I will take my chances paying taxes today vs having to pay taxes 30 years down the road on a million dollar tax deferred account. Also because social security will likley be eliminated or raised to a much higher age, most will need to live off something. The Roth gives this flexibility.

  81. PatentGuy says


    What makes you sure that 30 years from now the government won’t confiscate a fat portion of those tax free distributions? Maybe not in the form of “income tax,” but maybe some sort of a wealth tax, or a denial of benefits you would have otherwise received (e.g., medicaid) but for your having the tax free Roth.

  82. David says

    Neat analysis. Honestly, I had never really thought about the argument you presented. I’ve generally not been enthusiastic about any type of tax-deferred plan. New capital gains tax laws may change my views now, but it used to be that it was very much worth paying capital gains tax as versus monkeying around with the ordinary income received from a 401k plan.

    Still, one thing you don’t mention, and I can understand why, is investment earnings. What’s going to throw a monkey wrench into your argument is the variability of returns. If you’re working in a “lab”, you can assume the same total return in dollars. But, in the real world, it’s not as simple as assuming the same average investment rate. You can take 100 people, all averaging 8 percent (or 5 or 6 or whatever) and they could all end up with different dollar amounts after a set period of time. The longer the investment time horizon, the more varied the results. I also don’t think it’s realistic to assume the same dollar amount earned in both accounts or even a fixed spread between the traditional 401k vs the Roth due to the pretax contributions in the traditional 401k, unless you specify a fixed interest rate, the same time horizon for both investments and the same age for both individuals when they start as well as the same age at retirement. But, if you rely on fixed rates, I think you’ll probably have to contribute more to make up for the lack of return potential with equities and then your argument might not hold water any longer.

    The focus on “traditional vs Roth” seems to always focus on taxes, but this is really only one part of the analysis. And, it’s not even a part of the analysis that can be fully understood and worked though. For example, in your other article (, you assumed that the Government could change the tax laws to handicap the Roth. That’s true, but why couldn’t they do the same, or worse, with a traditional 401k plan (I’m thinking of a maximum accumulation limit for tax deferred earnings). I realize that you are trying to argue against a Roth and for a traditional 401k plan, but there are assumptions being made which, I think, are arbitrary guesses. Arbitrary because neither you nor I nor anyone else really knows how the issue of taxes will shake out 30 years from now.

    As an example of this, if you had told someone 5 years ago that we would have to dramatically increase taxes in 2010+ to pay for a nationalized health care system, most of the nation would laugh at you and try to talk through the tears generated from such laughter. No one’s laughing now.

    If you could assume all other things being equal, I think I would agree with your analysis between the two within certain specified limits. Actually, the pre-tax contributions might offset the taxes paid in the future so a Roth conversion might not even be necessary. My argument is simply that you don’t and can’t know that right now.

    In other words, I’m convinced that “tax planning” is a contradiction in terms. Once you start on the premise that you can outguess the whim of a yet unelected career politician, I think all of the following math, no matter how objective and concrete, will be wrong, misleading or inaccurate.

  83. Harry Sit says

    @David – We are talking about a Roth 401k here. A Roth 401k and a traditional 401k offered in the same plan have the same investment options. I don’t understand your variability of returns has anything to do with it. Whatever you decide to invest in a Roth 401k, you invest in the same in a traditional 401k, and vice versa.

    I agree with you on nobody can predict what the tax landscape will be in the future. That said, we still have to make a decision today. Someone has to decide whether to put money in a traditional 401k or a Roth 401k, or split between the two and how. Toss a coin? Automatic 50:50, regardless of one’s current income? You are a financial professional. When someone comes to you with this question, what do you say? Do you say “Do whatever you please. It’s going to be wrong anyway.”?

  84. David says


    RE: Variability of returns. What I’m referring to is CAGR vs average rate of return. Yes, the investments are the same in both accounts. What I mean is that when you compare the investment returns of a traditional vs a Roth, you might find out that the Roth provides more income even though the average rate of return assumption was the same (i.e. you don’t know *when* you receive the returns in advance) and you were able to save more in the traditional 401k. You might even be able to take advantage of the progressive nature of our tax system in the traditional 401k, but if your 8% average return in the traditional 401k turned out to be far less than the 8% average you earned in your Roth, it simply doesn’t matter. The Roth still wins. Or, you might find the traditional 401k plan does better than the Roth because the 8% average there was higher. Either way, the tax issue is only one aspect of the total equation.

    No, when someone comes to me, I do not say “choose whatever one you wish”. I think your argument is, in principle, the same as the argument which tries to argue in the other direction. This goes back to the idea that one is inherently better than the other. That would be the intrinsic approach. But, the alternative isn’t “do whatever you want” either, which would be the subjective approach. The choice should be objective. Which means, it depends entirely on one’s purpose, financial goals and a few other factors. It’s pretty involved and my approach is the exact opposite of how it’s normally done. I do not think it could be discussed in one or even several posts.

  85. Harry Sit says

    @David – Maybe you need to give an example here. With the same investments, how can the returns be different depending on whether one chooses traditional 401k versus Roth 401k? I would think both the CAGR and average return will be the same. No? The funds don’t know whether the money is in a traditional 401k or a Roth 401k. To the funds, money is money; they will grow the money the same way. If you are saying the investor will choose different investments depending on whether he/she is in a traditional 401k or Roth 401k, why would the investor do that?

    It sounds like you have an elaborate approach. If you are willing to share, you are welcome to write guest posts for this blog. We will see what readers say. If not, I certainly understand.

  86. Danny says

    You are completely off base with this article. The Roth is almost ALWAYS the best option for anyone. The word “traditional” doesn’t exist in my retirement planing. I don’t know about you, but I plan to be in a much much higher tax bracket when I retire. That’s the whole point in saving for retirement!

    The most popular financial example is the person that contributes only $100/month in an avearage mutual fund over 40 years will have $1,000,000. That person only contributed $48,000 of his own money. With the traditionsl 401K, he’ll pay taxes on $1,000,000. With the Roth, he’s already paid his taxes on the $48,000, and he can withdraw the $1,000,000 tax free.

    The great thing about the Roth is that you are only taxed on the money you put in, not the growth. When I retire, the vast majority of my 401K and IRAs will be growth, not money that I put in, and I plan to have $5,000,000. If I decide to pay cash for a retirement house, I don’t have to worry about taxes.

  87. David says

    @TFB– CAGR is the real rate of return, but averaging is just a blended rate of return with no consideration as to when the investment returns are earned. As a result, it can play with the actual dollar amounts.

    Here’s a simple example. I’ve exaggerated the returns a bit since it’s over a short time frame. But, the longer the time frame, the less variation that’s needed in the returns.

    I used 12 percent, since lots of people fantasize about 12 percent returns, heh, but any interest rate can be used to illustrate the same phenomenon.

    Yr 1 = 20% = $120,000
    Yr 2 = 4% = $124,800
    Yr 3 = -10% = $112,320
    yr 4 = 24% = $139,276
    yr 5 = 22% = $169,916

    Yr 1 = 12% = $112,000
    Yr 2 = 12% = $125,440
    Yr 3 = 12% = $140,492
    yr 4 = 12% = $157,351
    yr 5 = 12% = $176,234

    Yr 1 = 25% = $125,000
    Yr 2 = 30% = $162,500
    Yr 3 = 20% = $195,000
    yr 4 = 25% = $243,750
    yr 5 = -40% = $146,250

    As you can see, after 5 years, you get very different results, even though you’ve averaged the same return in each example. What I’ve basically outlined is the Monte Carlo Method. Usually advisers use this to illustrate hypothetical returns for clients and their probability of running out of money prior to death (a method that I think is flawed for a variety of reasons but that is another topic entirely), but I normally use it to point out that each time the MC software is run, you get a different prediction so if you’re overly focused on saving money on taxes, you’ll miss how the rate of return–and when you earn those returns–affects your retirement account in addition to the tax issue.

    The returns don’t need to swing as much over 30 years to create the same phenomenon. So, I guess what I’m trying to say is that taxes are just one factor. You could “plan” for the tax bite, and still end up losing out either way. My point isn’t that one type of account is better than the other. My point is that it’s about more than just tax planning. In other words, I don’t think you can make the argument for a traditional 401k by just focusing on the tax issue, because there are other variables involved.

    As I said before, I do not think the solution can be easily presented in one or even several posts. It’s not that it’s complicated or overly elaborate. It’s just that a LOT of pre-requisite knowledge has to be laid down before the solution can be presented and much of that information has little to do with actual investing strategies. And, some things I cannot give away, since it’s how I make my living, though my purpose was not to advertise on your site. I just wanted to point out something I noticed. It does not sound like something you’ve considered (or perhaps you have in other posts?). Either way, I think it’s something worthy of consideration.

  88. David says

    I apologize, if it isn’t clear, each 5 year block in the previous comment is a separate example to illustrate $100,000 growing at an average rate of 12 percent per year over 5 years.

  89. Vinod says

    One more factor : expense ratios of mutual funds/etfs are on total plan assets. In pretax 401k/iras, you are paying for uncle sam’s assets too. over 30 years, this adds up(magic of compounding on expense ratios). In Roth 401k/ira, you only pay expense ratio for your share(since earnings are tax free)

  90. Brian says

    The one factor that is not addressed is that taxes will likely be much higher in the future. This is especially true for Baby boomers and younger. Although it may not feel like it, we are actually at a very low relative tax rate presently, (prior to 1987, you need to go back to the depression to see rates this low) and with the baby boomer driven projected insolvency of Medicare and Social Security, and the total lack of a real social security trust fund (Yup, the lock box concept never happened), the issue is becoming critical. Take a look at the recent and very alarming increase to the national debt, now over 14 Trillion and growing daily and it is not much of a stretch to realize that higher tax rates are an inevitability. It is entirely likely tax rates will increase significantly, so a better way of looking at a Roth 401k is like locking in these historically low tax rates. Works for Mortgages, and it works here too.

  91. john says

    Income taxes are going to drop in the future. Additional VATs, tolls, sales taxes, and user fees will be added. I am staying with the traditional 401K.

  92. patent guy says

    I don’t know what income tax rates will do, but I have seen the future. It’s a place about 70 miles east of here, where it is lighter.

  93. David says

    To all of the folks that keep hitting the tax angle, I think that TFB has a very good argument, within that limited context. But, my argument, which takes into account a Monte Carlo scenario, can neutralize any tax scenario. As an example, plus in scenario 2 into a Roth and then plug in scenario 1 into a traditional. It doesn’t matter what your tax bracket is. The Roth wins. Reverse it, and plug in scenario 2 into the traditional and 1 into the Roth. The traditional could win (assuming existing tax rates).

  94. David says

    Great article. As a math major and someone who works in the industry, I spend a lot of time trying to counter the hype that has been created regarding the Roth. Folks, the Roth is not better or worse, just different. It simply gives you the option to pay taxes now. A Roth does not grow “tax-free”. Your entire account and all of the growth that it might achieve is fully taxed up front. For many people, the Roth is a trap and they will never know that it hurt them.

    Example: You are a farmer. Your fields are flooded, but your neighbor has some extra fields. He offers to “rent” them to you for 30%. Do you give him 30% of your seeds before they grow? Do you give him 30% of the crop after it has grown? Answer: It doesn’t matter. 30% is 30%, before or after growth. If you put your investments in a Roth, you START OUT with less money invested because you pre-pay the taxes on the entire account, including all of the future growth. It “feels” like the Roth is better because we can say “yeah, but you never pay taxes on all that growth”, but the math proves otherwise.

    The feds weren’t stupid when they created the Roth. They were looking for sources of income now by allowing you to pre-pay your taxes. They are still getting their cut, and more in some cases. If you stop looking at the caps and compare earned wages invested into both plans, they come out the same if your tax rate is the same for your whole lifetime. Exactly the same.

    Most of the people I deal with have a lower income in retirement, and therefore are better off with a tax-deferred (traditional) vehicle.

  95. David says

    @David. You’re still missing the point. Your investment returns are not linear unless you invest in a fixed interest account, somehow. Otherwise, it *might* make a difference what you invest in, even if your tax rate and contributions are the same.

  96. Danny says

    @David Your math is very flawed when you say that “A Roth does not grow “tax-free”. Your entire account and all of the growth that it might achieve is fully taxed up front.”

    If that is the case, then we are double taxed in normal investments. Even if that is the case, the Roth still grows tax free.

    If I buy a normal mutual fund with $10,000 and 40 years later it turns into $1,000,000; I’m taxed for that $990,000 of growth on top of the tax I have already paid for that $10,000 of income. However if I instead contribute that $10,000 to my Roth 401k, I’m not taxed on that $990,000 of growth 40 years later. I was only taxed on the original $10,000.

    As far as Roth vs. Traditional….In a 401K, people do not specify dollar amounts when telling their company which they want to contribute. They give percentages. This % is of their gross income whether they do a Traditional or a Roth 401K. If someone contributes 10% of their $50,000 yearly salary, $5,000 is going in whether they do the Tradiotional or the Roth. Therefore, doing the Roth forces the average person to save more.

    I also don’t understand how the average person is in a lower tax bracket when they retire. The average working person has 2 -3 tax deductable children plus a tax deductable mortgage. A retired person whom has lived life in a responsible manner has neither of these. When I retire, I want to be able to dip into my retirement and make a big purchase (a boat, a car, a vacation house) without the worry of taxes.

    I buy invest ONLY in the Roth and will continue to do so.

  97. bob says

    @Danny: When you compare your Roth 401k to a Traditional 401k, it is the same supposing your tax rate is the same. Supposed you have 25% marginal tax rate. Then you needed to make $13,333 in order to be able to get $10,000 to contribute to your Roth 401k after tax. If you had put that $13,333 into a Traditional IRA, with the same investment choices, it would have grown to $1,333,333. Then if you are taxed at 25% at withdrawal, ultimately you are still left with $1,000,000.

  98. Kevin says

    A lot of math flying around here. I’m looking at this simple figure. Let’s say I have $10K to invest this year, and can choose between Roth or a traditional 401k. In my tax bracket, if I choose Roth, I’m paying $1500 in fed tax on that $10K. If I go traditional, I save that $1500, but if that investment grows 5% annually for 30 years, I’ll have roughly $43K and will be paying taxes on that, which will be more than $1500 I’m sure. Therefore Roth wins. Yes or no?

  99. Brandon says

    This is a great discussion and I am so glad I stumbled upon it. I want to contribute to it and please comment back with any opinion that you may have. The target audience for a discussion like this is probably geared more towards the more financially responsible people of this world who will actually take the time to read this article, so there may not be many people in my financial situation reading this. But the fact remains that there are many people that make in the $50,000 range that do not plan on making much more than $83,600 by retirement (understanding that the maximum for the 25% tax bracket will surely change well before my retirement, but for the sake of argument). My corporation matches my contribution to my 401(k) up to 6% of my pay. I contribute exactly this amount, 6%, because of the 100% match and because I feel it’s not worth contributing more due to my current financial needs.

    For the many people in my situation, living in states like Pennsylvania that are “income tax friendly” that are not planning on moving, wouldn’t the Roth 401(k) be a given? The taxes are paid now on what I contribute (employer’s funds go into a traditional 401(k)) and I will only be contributing my 6% match. The money that I am paying in taxes for my contribution will not be invested into any kind of retirement fund, just coming out of my pocket money and savings account money. So I am paying the state and federal tax, but the money is now earning tax-free interest while in the 401(k) account and again the amount that I paid in taxes on my contribution cannot be invested into the account to gain the same interest yield over the years to pay the taxes that would be owed on the interest if it was in a traditional 401(k).

    I thought I would enter in this comment because this entire thread really doesn’t cover the guy/girl that will only be contributing a certain percent until retirement to get the company match and nothing more. So the situation is kind of like Chim’s comment #26 but slightly different; if I contribute $2,000 this year (and am in the 15% tax bracket using his example) and pays the $300 in taxes my earnings from it are tax free at retirement. So if that $2,000 turns into $10,000 at retirement I saved a lot of money investing in the Roth. Since the maximum I could have contributed was $2,000 (due to in this hypothetical situation that my $2,000 investment is 6% of my yearly salary) isn’t the Roth 401(k) the best answer?

    The only true factors to consider seem to be today’s tax bracket and state taxes paid now versus tax bracket at retirement and the amount of interest earned over the years. But, if the money taken out of the 401(k) after retirement is kept low enough so that one’s yearly income is under the maximum for the 25% tax bracket (being that my yearly earnings now fall in the 25% tax bracket), the factors are now only state taxes paid now versus interest earned over the years. Unless I was to only take out enough money per year after retirement to keep just under maximum income level for the 15% tax bracket, isn’t the Roth a no brainer for someone in my situation? I’m sorry if this is all a bit confusing, but please let me know what you think. Thank you.

  100. Harry Sit says

    @Brandon – If you are going to invest 6% no matter what, I agree with you: Roth 401k is better. But why set that artificial constraint for yourself? If you are going to do 6% Roth 401k, you are going to dig into your savings to supplement your now smaller paycheck. If you are willing to dig into savings, why not do say 8% to traditional 401k? You end up with the same paycheck as 6% to Roth 401k.

    Pennsylvania doesn’t tax 401k plan distributions but it does tax wages. If you use Roth 401k, you will pay PA tax from your paycheck whereas if you use traditional 401k you won’t pay PA tax from either your paycheck or your eventual withdrawal from your 401k plan. Why pay PA tax when you don’t have to?

  101. Brandon says

    Thank you for your fast response. Your questions have the insight that I was looking for. After reading through these comments I learned a lot and thought long and hard about my comment above, but I never considered that the 25% federal taxes I would be paying now when contributing to a Roth 401(k) at 6% would give me the same paycheck that contributing 8% to the traditional 401(k) would (being that 25% of my contribution that I pay on my taxes would be exactly 2% more I could invest into the traditional). Without going into a major math equation, the extra 2% into the traditional (earning interest over many years), though not being matched by my employer, would most likely cover my taxes that I would be paying on both of my contributions and my earned interest at retirement to the extent that paying the taxes now when contributing to a Roth isn’t saving me any more money in the end, correct? Also, the state taxes I would be paying to Pennsylvania now would just be an extra “ding” to my total earnings.

    With this extra analysis, the traditional seems to be the winner. And if my withdrawals from my 401(k) after retirement could still keep me under the maximum income for the 15% tax bracket (after all, I will be in my 60s and probably not running around spending money like I do now) instead of the 25% bracket that I am in now, then it seems that the traditional 401(k) is a definite winner. Is this correct?

  102. David says

    @Brandon–it might be the winner in this scenario until you reach age 70 1/2 and then start having to take withdrawals from your account. Don’t forget your RMD. Also, don’t forget to add 1/2 of your SS income to the rest of your income. If you are single and exceed $25K then you’ll start being taxed on your SS. If you’re married and you and your spouse’s combined income exceeds $32K, you’ll be taxed on SS. I think those are some of the variables you’d have to account for in your situations. Also, it depends on what your contribution about is in terms of dollars.

    But, if your total retirement savings were $83,000, then the traditional 401(k) would probably be the better bet assuming tax rates don’t change and assuming you don’t make much money in retirement.

  103. Tim Lawler says


    Great post, and extremely informational! I am a military physician, and the govt eqivalent to a 401k, called the Thrift Savings Plan (TSP), is considering giving the option of a Roth 401k in the next year or two. We’ll see if they actually do it, but it will definitely give me something to think about! You are a great resource that I will now refer to in the future. Take care.


  104. Allen says


    With respect to your first point, I was wondering whether other income of you and your spouse in retirement (e.g., accumulated pre-2008 non-Roth 401(k) contributions, Social Security benefits, accumulated employer contributions to 401(k), accumulated “profit sharing” contributions, IRA savings, variable annuities, and other outside investments / savings) wouldn’t act to quickly fill in the lower tax brackets in retirement making the Roth 401(k) more attractive? With these various potential sources of post-retirement income, it seems that it might not take very long at all to reach relatively higher marginal rates.


  105. Doug says

    I agree with most of your assessment (and won’t bother arguing whether tax rates are likely to go up or down in the future).
    I am curious about one thing though — how have plan sponsors taken to Roth 401ks? They must make passing ADP compliance testing even harder.
    They already had to deal with low wage earners who were struggling to make ends meet and don’t feel they can afford to defer any of their income, but now they have to deal with this whole new group of recent college grads just starting out who expect one day to be moving up into a higher tax bracket. Might as well wait until you hit the 25% marginal bracket before contributing to a traditional 401k — in the meantime capitalize on prepaying your taxes at a lower rate by putting money into a Roth 401k (Roth IRAs were bad enough, but now its so much easier when you’re employer has already arranged all the paperwork for you).
    Do you happen to know if this has been much of an issue for plan sponsors? I feel like there’s a certain conflict of interest there — they want to give their employees good financial advice, but they also really want the NHCEs to contribute to traditional accounts so they can pass their ADP testing and not have to make forced distributions to all the company execs, or take the costly measures of making safe harbor contributions to everybody’s accounts.

  106. Harry Sit says

    @Doug – Roth 401k contributions are added to pre-tax contributions in ADP testing. To the extent employees shift from pre-tax to Roth but contribute less, the employer takes a small hit in ADP testing. However adding Roth 401k also attracts contributions from employees who previously don’t contribute. Overall I don’t think adding Roth 401k has much negative impact on ADP testing.

  107. Doug says

    Ah, thanks. I’m was having trouble finding that wording in the official regulations (I’ll just have to keep digging through the IRC…). I took the financial planning CEBS tests back in the late 90s, but I haven’t kept up on changes to the regulations (there have been a lot of them) over the last few years since I’ve been sitting out the labor market (and taking advantage of the opportunity to convert portions of my pretax savings year by year).
    I was assuming Roth and Traditional plans would be treated as separate plans and as such, the traditional deferred plans would have to pass ADP testing and the aggregate of the plans would have to pass ACP testing (of course I was also thinking that the combined limit was only subject to higher aggregate section 415 limits).
    So I guess the key is that ADP is really a misnomer now — leave it to our lawmakers to redefine the word “deferred”.

  108. Roth fan says

    Roth 401k wins because it can be rolled over into a Roth IRA and no RMD are required at 70 1/2. This allows the account to continue to grow, while the traditional account has to be depleted. The forced taking of required distributions deplete the traditional account while the Roth account is allowed to grow, tax free. Thus the Roth account can continue to grow, even after 70 1/2. In addition, if you have qualified income, you can continue to contribute to your Roth account. You can’t do that with a traditional account. Thus, you are able to see your account balance continue to grow, while your traditional counterparts will have to take distributions, pay taxes on the distributions, and potentially have social security benefits taxed more because of the added income. I think without the rmd issue, it would be very difficult to make a compelling argument either way. But the rmd issue seals the deal for me. With that comes the ability to pass it on to my heirs and have a stretch Ira which would pass tax free income on to my children or grandchildren for decades, just from a Roth 401k that I rolled into a Rorh Ira.

  109. KD says

    Roth fan, if you play with the spreadsheet, you will get appropriate answer – roth or traditional 401k. Its the tax rate at the marginal dollar that determines the choice. rmd issue is moot as trad. 401k can be converted to a roth ira too, just pay taxes while doing so while roth 401k is contributed after paying taxes. one way or the other, you pay taxes. how much or how little is the all important question and it is answered very well by the spreadsheet.

  110. Roth fan says


    I respectfully disagree. A rollover is much different from a conversion, particularly from your own psyche. I much rather pay tax on the small amount going into the Roth 401k, which will ultimately be rolled over into a Roth IRA, rather than paying potentially hundreds of thousands to the IRS trying to convert a traditional 401k to a Roth IRA. My ultimate end game is to be on a Roth IRA for the reasons I stated earlier. So why not avoid the hassle of the conversion. That small deduction you lose pales in comparison. So you may argue that each of the small tax deferred contribution added up and invested over time would equal the amount of the tax paid at conversion, I would not disagree. But why even bother. I’d rather pay my tax on the seed, not on the crop.

  111. Harry Sit says

    @Roth fan – Actually each of the small tax deductions added up and invested over time would be more than the amount of the tax paid at conversion, for the reasons listed in the main post. In addition, conversion doesn’t have to be all-or-nothing. Between age 59-1/2 and 70-1/2, you can do spread your conversions over 11 years. Even after 70-1/2, RMDs are very low – 4% to 5% – just enough for your spending money. You can continue to convert for another 10 years if you haven’t converted everything by then.

  112. Roth fan says


    That’s why i believe knowing your end game should be the determing factor. Ultimately, if my plan is to roll my Roth 401k over to a Roth IRA, then contributing to a traditional 401k when I have the choice to contribute to Roth 401k adds the unnecessary complexity of conversions. Also, the great unknown is tax rates. Most assume they will be in a lower tax bracket at retirement. But that is a great leap of faith. Today’s tax rates are historically low. For most of our tax history, the highest tax bracket has been over 50%. As a result the lower tax brackets have been reduced. But that tax policy can easily change, particularly since our governmental obligations are growing not declining. So even though our retirement income may be less than our current income, it may be taxed at the same rate, or more. But with a Roth, you get that out of the way. I also said earlier about the impact of the rmd’s on social security benefits. But the thing that seals the deal for me is at 70 1/2. The IRS wants it’s money back, whether you want to take rmd, no matter how small a percentage. You have to decrease your balance, whether you want to or not, whether you have additional income or not. Meanwhile the Roth account, if rolled over to a Roth IRA, continues to grow and compound. And you can even continue to make contributions. You know have a tremendous asset that you can leave to your heirs. It is at this stage, that the Roth account clearly surpasses the traditional account. And while you can make the conversion, writing large checks to the IRS is not something I have any desire to do, especially when I can plan to avoid it.

  113. Roth fan says

    Finally, with a conversion, you will need money outside of the retirement account to pay the IRS for it to even work, which again is deleting other assets just to get to a place where you could have been at the start.

  114. Ethan says

    To use the language of Donald Rumsfeld, I feel that future tax rates and policys are a known unknown. When choosing a Roth, amongst other considerations I felt that I would rather pay a rate that I know rather than a rate that I don’t. As you said, there are so many different scenarios 30 years out and you don’t have enough brain cells to compute. Therefore, take the rate that you know. How low could future tax possibly be in a country that has a giant unfunded social security ponzi scheme. Not to mention the unknown unknowns of how policy might shift.

  115. Matt says

    I realize I am responding to an old post, but I just came across it. I agree with everything you said, but I think there is one more class of investor for whom the Roth can be a good choice.

    For investors that have a mix of low and high risk investments, it makes sense to have both a Roth and a Traditional IRA. If you put your high risk investments in the Roth account and everything goes as planned, in the far future, these investments will have grown substantially and the earnings will all be tax free.

    As a silly example, suppose someone’s portfolio is comprised of bond funds and lottery tickets. It makes sense to buy the lottery tickets with Roth dollars and if/when the investor wins the lottery, all earnings are tax free.

  116. Harry Sit says

    @Matt – No problem with commenting on an old post, as it is still relevant today. What if it didn’t go as planned? Say the lottery tickets don’t win, you lose all your investments if you buy them in a Roth account. If you buy them in a Traditional account, you at least got the tax deduction. The government in effect subsidizes your loss in those lottery tickets in a Traditional account whereas you are all on your own in Roth.

  117. steve says

    The Roth makes sense to me because capital gains within the Roth are ignored. There is no headache of considering short vs long term gains, no complex record-keeping and in the past two years I have saved far more in excluded capital gains taxes than I would have going the 401k route.

    Of course if you don’t trade much, or if you aren’t doing well in the market the above is moot.

  118. Mike says

    Great article and follow-up comments, they really give you a lot to think about.

    Correct me if I’m wrong, though, but doesn’t it make more sense for the Roth if you’re going to contribute a set amount regardless of whether you use a Roth or Traditional 401K? (I think a previous poster brought up the point of contributing a set percentage of salary, which is the same idea.) For example, I’m going to contribute the max (currently 16,500 this year), and hopefully always will, so it’s not like I can contribute a little more to the Traditional if I go that route. And with a Roth, I can pull all of the gains out tax free. If I contributed to a Traditional 401K, I have to pay tax on the gains. So wouldn’t the Roth be better in such a situation?

    I guess an argument could be made that you could invest the tax money saved with a Traditional 401K outside of that vehicle where it would be subject to capital gains in retirement. But, if you assume someone had enough to make the same additional investment while investing in a Roth (which some people do), that makes that point moot. Am I missing something here? Thanks!

  119. Jason says

    Great article. I had a question regarding my situation that I would like your input.

    I am a sole proprietor with no employees.

    The Solo 401k plan contribution limits for 2011 are $16,500 for employee contribution plus 20% of net business income for the profit sharing contribution portion (Max $49,000).

    My questions are:

    1) Would it be possible for me to contribute the $16,500 portion to a Solo Roth 401k, and the profit sharing portion of $32,500 ($49,000 – $16,500) or less to a Traditional Solo 401k?

    2) Assuming I am in the same tax bracket in retirement, would I be better off investing all $49,000 into a Traditional 401k or splitting it up into a Traditional and Roth (as described in the previous question)?

    Thanks in advance,

  120. Robert says

    I have thoroughly enjoyed reading both your article and all of the contributions to include your timely responses. After reading through all of the posts, I believe I have a better understanding as to what option of the 401k might be more of an advantage depending on circumstances. Clark Howard seems to be a big advocate of the Roth 401K based on the assumption that taxable brackets will be considerably higher than today because of all the unfunded liabilities and for the simplicity of knowing exactly how much income available you will have available regardless of taxes.

    For additional clarification, there is mention that someone with a traditional pension plan may benefit more from a Roth 401k than traditional.

    Would you mind explaining a bit more in detail on what the salary threshold may be?

    I will be retiring from military this year and will soon start a new career with an employer that offers a Roth 401K. Here are some additional details for my initial thoughts of which I would like to hear your take:

    • Contribute 10% of total income (new employer) which will be slightly under the max contribution and increase 1% a year thereafter until I reach max contribution to 401k.
    • Military pension of roughly $56K during my 27th year of military retirement the same year of which I plan to retire.
    • Military pension will increase yearly indexed by inflation (assumption 3% annual inflation rate).

    Thanks in advance for your time and consideration.

  121. eric says

    TFB is not saying traditional will always trounce Roth 401ks. He’s simply demonstrating scenarios where a traditional will prevail and debunking the myth that the Roth 401k is always better.

    I prefer Roth 401ks for myself (my net rental income alone pushes me into the 33% tax rate), but I can clearly see that if someone were in a high marginal tax bracket today and knew that he would have several years of no income (ie, early retirement) that a traditional 401k would squash a Roth 401k. In fact, a traditional 401k can allow one to completely avoid paying income tax on contributions by simply shifting the distributions or rollovers into a Roth IRA in zero income years. The only better tax avoidance scheme out there is the HSA where you get to deduct contributions but withdrawals are tax-free (for qualified medical expenses) regardless of income levels.

    If we all had crystal balls and knew future tax rates and our own marginal tax rates, we wouldn’t be having this discussion.

  122. chris says

    I appreciate this discussion as it offers real examples and well thought out theories as to what is best.

    We have a couple weird circumstances. 1) Our state does not have state income tax. 2) I am a teacher that will receive a pension which is taxed in retirement. 3) My wife earns a high salary that will surely get higher over the years; she is 31 and would like to work a long time.

    Her employer offers Roth 401k. Previous contributions, the company’s match, and all bonuses are lumped into the regular 401k. For 3 years, she contributed to regular 401k and we had separate Roth IRAs. Now, our combined income puts us above the limits for Roth IRA contribution. Because we cannot contribute to a Roth IRA anymore, is it safe to assume that the Roth 401k is a good option for us? I have not seen anything on income limits in the discussion. My apologies if I missed it earlier. The more I read, the more confused I get with what applies to our situation.

    PS, I do have a small 457 plan as well as a deferred annuity. Our current Roth IRAs amount to a small amount (current balance of $35k) of what we would need in retirement.

  123. chris says

    …one other point.

    We do NOT contribute the max to the Roth 401k; although we do kick in 6% that will result in a 5% match from the company. Our 6% does not get us to $16,500, but that is mostly because we are not thrilled with the investment options in the plan. Our extra goes to a Fidelity account because we can do so much more with it.

  124. Sally says

    Great read. The truth is many of us will NOT be in a higher tax bracket when we retire. I am putting 20% of my income into retirement. I don’t think I’m going to actually make more when I retire. I plan on living on much less as I will pay my house off before then. With no house payments and no saving for retirement, one will not need as much. Also ax rates will not inevitably go up. We can’t predict the future.

  125. Jae says

    Hey TFB, first time poster here. Found your blog on the Boglehead forums and love it. I had a question about my girlfriend’s financial situation, she seems to be a tweener.

    She works in fashion. Her company offers Roth and Traditional 401k’s.

    Factors for Roth:
    She makes 35k/year and anticipates her salary moving higher as she ages. It’s my understanding that the last 1k of her salary is taxed at 25%?

    Factors against:
    CA has a high state tax (6% for 35k I believe). She might move to NYC later, which also has a high state tax though.

    Should she go with the Roth or the Traditional? Also, if Roth, would it be wise to invest the first 1k off the top to the Traditional to avoid the 25% rate and send the rest to the Roth 401k?

    Thanks for any help.

  126. Harry Sit says

    @Jae – The $34k number is taxable income, not gross. If she earns $35k gross, after standard deduction and personal exemption, she’s solidly in the 15% bracket now. State tax certainly complicates things. If her income will soon double or triple, Roth probably makes sense. If she’s just getting a cost-of-living raise, maybe she won’t be in a higher tax bracket when she retires.

  127. David says

    Dear TFP,
    I am amazed as how you simplify and hit home the most important points. Big thanks for you!! to spend your time to explain to us this is truely appriciated. I am higly litrate but buisness illitrate individual who have little understanding of how the traditional IRA, Roth IRA, Roth 403(b) and all other modes of investment work. in my work I have the advantage of 403(b) which is matched one to one up to 6% and then Roth 403(b) option. I was wondering if I should continue with the 403(b) after matching the 6% or to jump to the Roth 403(b). you have answered most of my questions. after reading your article and the comments, I am now a proud and much more knowledgable individual. Thanks to you.
    if I may ask you particular question:
    I am a 41 years old married with total house hold income of 150k. this I hope will remain so till around age of mid 55-60. after that it will be part time job earning probably half to 30% of this. considering this and knowing I started saving late to retirment, after maxing the matching, should you still say only 403(b) only? even after reading your article, I was thinking of contributing some to Roth 403(b) incase to either supplement income after 59, or even to transfer to beneficiaries.
    of all though, it is a breath to know that the world is full of people like you who truely like to enlighten and help!!

  128. Celtic says

    There are a lot of comments here, so if this has been covered, my apologies for the spam.

    My annual gross income is too high for a Roth, but this year I’ll have significant real estate investment losses that will push me down into the range where I’m eligible. I was simply investing in a TIRA until I realized this, so wasted $4k in taxable contributions (couldn’t reverse it without converting my entire IRA to a Roth – bummer). However, the remaining $6k for me and my wife’s $5k will all go into the Roth.

    The point? Be opportunistic in seizing on Roth situations if your year-to-year taxable situation varies. Good luck to all, and thanks to TFB for all the posts and insights.

  129. bill says

    If you consider time value of money and depreciating $, paying tax at a later time makes sense (sorry guys, i haven’t read all 142 comments yet)

  130. Steve says

    I put $6k into a Roth in 2008, and another $6k in 2009 for a total of $12,000. Since that time my Roth which is at Interactive Brokers has grown to a value of about $25k, (it was as high as $36k several months ago, but I’m not worried). All of the $12k+ is in short term capital gain. The beauty of the Roth for me is I don’t have to pay it! Even better, I don’t even have to track it for IRS purposes. The freedom to do short term investing alone has long since far exceeded the taxes that I paid on the initial $12k to start with. If you enjoy playing with stock, and enjoy buying and selling, being able to do so without having to pay Capital gains is quite wonderful and at least in my case, quite remunerative.

  131. Lovey says

    My employer now offers a Roth 401K along with the traditional 401k as well.

    I contribute 8% of my salary while my employer contributes 6.5% of my salary as a match. To get the matching contribution, I only need to put in 4% of my salary.

    Should I take that 4% above what I need to get the match and redirect it to the Roth 401K?

    My husband and I both have Roth IRAs. We were not contributing the max allowed but will be able to starting this year.
    His 401k is the gov’t TSP.

    We are 21 & 25 years from retirement.


  132. John says

    I am surprised that the author of this article ignored earnings. I ran a simple modle in which a 25 year old contributed $10,000 per year for 40 years. I assumed a 6% rate of return over those years. His nest egg would be $1,640,477 at 65 years old. During those 40 years, he would have contributed $400,000 and saved $100,000 in taxes for pre-tax or paid $100,000 in taxes for contributing to a Roth (assuming a 25% tax bracket). Withdrawals of the pre-tax account would be taxed at $410,119 (again, assuming a 25% tax bracket). The Roth account would be withdrawn at $0 in taxes. To sum it up:

    Traditional: Contributions – $400,000 – Up front Taxes – $0 – Withdrawal Taxes $410,119
    Roth: Contributions – $400,000 – Up Front Taxes – $100,000 – Withdrawal taxes $0

    I don’t know about you, but I would prefer to pay $100,000 versus $410,119

    At a 4% return on investment, the numbers are as follows:

    Traditional: Contributions – $400,000 – Up front Taxes – $0 – Withdrawal Taxes $247,066
    Roth: Contributions – $400,000 – Up Front Taxes – $100,000 – Withdrawal taxes $0

    At an 8% return on investment, the numbers are as follows:

    Traditional: Contributions – $400,000 – Up front Taxes – $0 – Withdrawal Taxes $699,453
    Roth: Contributions – $400,000 – Up Front Taxes – $100,000 – Withdrawal taxes $0

    The majority of your nestegg shold be earnings. It is silly to have this argument without considering earnings.

  133. ogd says

    OMG @John and other guys. He’s said this 100 times already…

    Really — multiplication is commutative. If you pay tax now, there will be less to invest, less basis for that growth, and a much lower amount to be withdrawn tax-free. How much smaller? Exactly today’s tax rate.

    @John: the upfront taxes are paid *before* the investment. That’s why they’re upfront. So instead of 10K, there’s only $7500 left to invest each year. Do the math, and it will be identical to the last digit. It’s a simple identity:

    $X * ReturnRateOnEachDollar * (1 – TaxRate) = $X * (1 – TaxRate) * ReturnRateOnEachDollar

    Where $X is the amount of disposable income you have to invest. So the differences are, 1) are you bumping against the limits with the $X, or 2) will the TaxRate be different due to various circumstances?

    TFB: this is an excellent article, thank you so much. Lots of things to think about. I am in fact bumping againt the contribution limitation, so one option is to hedge (large-ish company match would go to Trad 401k).

  134. Simon Martins says

    @ogd: I’m not sure where you got the $7500 value. John is comparing investing $10k in both traditional and Roth, not putting different values into one and the other.

  135. Harry Sit says

    @Simon Martins – The money to pay tax has to come from somewhere. If you are able to do $10k in Roth 401k, you have enough money to do $13k in Traditional 401k. That’s an apples-to-apples comparison, not $10k in each.

  136. Tony Foster says

    The writer of the article fails to point out the most important point. All the money you earn on those already taxed contributions is TAX FREE.

  137. Mitch says

    Great job TFB.

    I finally came to this realization within the last year. Starting a new job that put me in the 28% bracket, and where I’ve historically contributed to a Roth IRA after contributing enough to get the full 401K match from my past employer, I started contemplating a Roth 401K.

    I then had some fun with excel…

    I realized in order to pay an average tax rate of 28%, which is what I can deduct each marginal 401K dollar at, in today’s terms, I’d be earning over $300,000!!!!! Sounds like a great problem to have…

    If you don’t believe me, head over to dinkytown:

    So as you highlighted, that marginal 28% benefit I’m getting now with a trad401K overwhelmingly supersedes the roth option. With that said, I’m doing 17K to a trad401k now.

    The other nice benefit is it lowers my AGI, which allows me (although I’m phasing out) a better chance to do a Roth IRA as well!

    And to the people that still don’t understand why 10K pretax is not the same as 10K after tax (when contributing), you really need to re-visit 6th grade math!

  138. Alex says

    Excellently written. Your analysis was complete and provided several points that I have yet to hear from any other author on the subject.

  139. apple says

    what is best for me with the Roth is I get to pick the investments!!!

    I have always complainted that my investment choices are limited to the 20 picks my company offers.
    Honestly, my 401K consist of 5 different mutual funds. Some I like others I would never buy on my own.
    I have 5 mutual funds that are basically the least of the 20 evils..LOL.
    The ROTH is with sharebuilder and I have a wide assorment of stocks, bonds, CEF and EFTs.
    I am able to create greater diversity and a much higher yield.
    I think this freedom of choice will be the only way I retire comfortably.
    I know people in my company that have over a million dollars invested in….well they don’t really know????
    Further, this article fails to mention the lifetime hidden fees you pay from 401K mutual funds!

  140. Bundy says

    Would this year be a good year to max out on the 401k Roth? My take is that PAYROLL taxes are cut this year, hence in reality you are paying 2% LESS taxes. Next year the cuts are going to expire, the taxes are going to roll back in. I am in the lower bracket – 25% and was wondering if it was a wise move…

    I am not planning to save my Roth IRA for retirement…I am actually saving it for a first-home purchase. the first 10,000$ in earnings are TAX FREE. So thus, it might be strategic move where I save 30%( federal,state,city, etc) in taxes, or $3000.

    Thanks in advance for your suggestions!!!

  141. Harry says

    Bundy – Payroll tax has nothing to do with this. You get the same reduction in payroll tax whether you contribute to traditional 401k, Roth 401k, or you don’t contribute anything at all. And the same reduction will go away next year no matter what.

  142. Victor The Cleaner says

    Hi Harry: that is true, but I took advantage of the 2% payroll tax reduction/credit and shifted it towards my 401(k). I am pretty much at the contribution limit now, which was my personal goal.

  143. Jane says

    Well TFB, after reading some strong augments on “the OP missed some critical points” and your repeated explanation on the communicative property of multiplication, I feel for you. Dear TFB, you have summarized this topic better than almost any other articles, and you deserve a pat on the back. Good job! Leave those guys to their spreadsheets…I think they will realize the mistake eventually one day.

  144. kathy says

    I just finished listening to a webinar about the benefits of the Roth 401K vs traditional 401K IRA. I understand the communicative properties of multipication but is there a benefit to opening a roth 401k and then rolling it over to a regular roth 401 in order to avoid the RMD? I guess in my mind the beauty of a Roth 401 is to never have to take the RMD if you do not need to.

  145. Harry says

    Kathy – Yes Roth 401k rolled over to a Roth IRA will avoid the RMD but “at what cost” is the question. I’m not exactly sure why RMD is such a bad thing if it means you pay a higher tax rate in order to avoid it.

  146. Steve says

    I’m starting a career at age 22 and am putting away 20% of my salary into a company 401k. This means I am hitting the limit and then some, with the rest going into an after-tax account within that savings plan (which I will convert to a Roth IRA until I am ineligible for it due to income limits). I live in Alaska, with no state income tax. I will be in the 25% tax bracket for the next few years. I get a 9% company match, and and a 6% company pension on top of that. Both of those are pre-tax. I’m of the mind that my tax rates will be higher when I retire, either due to living somewhere with a state income tax or tax rates in general going up. As such, I feel it makes sense to make all of MY contributions to a Roth 401k, with the other 15% from the company going into a pre-tax account. Does anyone here see a flaw in this thinking? Thanks!

  147. Joe says

    The biggest thing most people here are ignoring are the benefits of tax-free growth in the Roth if you satisfy the requirements of 5 year aging (you’ve had roth assets for at least 5 years) and you’ve bypassed age 59 1/2. Take a very extreme and simple example (obviously returns will vary depending on investments and many other factors): If you invest $5k into a Roth 401k or IRA and never put anything else into it at all, but made outstanding investment selections and turned that $5k into $500k, you may withdrawal that entire $495k from the account without paying a single nickle in taxes, as long as you satisfy the above rules. That is an enormous advantage, especially when you have a long period of time to allow for these gains to come into fruition by compounding your earnings.

    The second huge benefit of the roth is that, unlike traditional 401k’s and IRA’s, you may withdrawal the principal amount at any time without paying anything in taxes or penalties. You may do this because you’ve already paid the tax on it – the only part you can’t touch early without tax and penalty is the growth of your principal (as described above). This allows for Roth to potentially act as an emergency fund of sorts.

    After stumbling across this forum, I felt compelled to add this as I was shocked to see almost no mention of it.

    Source: Certified Financial Planner professional and 10 years of financial advisory

  148. Ben says

    Great post, I am with you TFB. For people who don’t get it (commutative property of multiplication), I guess they forget paying tax upfront is actually lowering how much money they really invest. I saw several people try to provide simple example of one time investment and grow tax free, and argue that they will save a lot (tax) at retirement. I think that is wrong because the basis is different.

    Let me try my way if I can convince them:
    If you put one time investment $10000 @ 25% bracket into Roth 401K, you only contribute $7500 ($10000-$2500 on tax upfront). Now you grow tax free. Compare traditional 401K, you really put whole $10,000 (pre-tax) into your IRA.
    If same investment strategy applies, both grow 10 times more, Roth 401K turns $7,500 into $75,000 (tax free). Traditional IRA grows from $10,000 to $100,000. If the tax bracket remains the same at retirement, you will get same amount $75,000 ($100,000 – $25,000 tax).

    People who favored Roth 401K due to growing tax free forget that when they compare same amount money in Roth and Traditional account, that is different basis. In order to contribute $7500 into Roth IRA, you need $10000, which can be totally invested in traditional IRA. If you only put $7500 into traditional IRA, you will have additional fund available $2500 x (1-0.25) that can be invested as well.

  149. Matthew says

    Look you can spin your numbers any way you like and you can try to justify your decision till your blue in the face, but you cannot escape the RMDs that are imposed on 401K and traditional IRA accounts at age 70. If your investments do really well, which we all want, then you will be faced with the Required Minimum Distribution imposed on all but the Roth IRA accounts. The minimum is calculated base upon life expectancy tables at the IRS. This means that for most of us some where along the lines we will be forced to take out more than we want in a given year. In 50% of those case it will bump us into a higher tax bracket.

    Since most of us here are not in the highest tax bracket and since we don’t have a crystal ball to see what taxes will be like when we retire, it makes sense to treat this subject with some respect. Both account types have something to offer. If you really look at the numbers you will begin to see that which investment avenue you take is going to be determined by what your company is offering as a match and what you can afford in your monthly budget. If your company match is not as high as your tax bracket, then you should take a serious look at the Roth option.

    My rule of thumb is max out your company match (assuming my rule matching rule from above) and then max out your Roth options.

  150. Adam says

    Since this post goes into the Roth and traditional 401ks so well, I thought I’d ask question that also fits into choosing strategically.

    Are the Roth 401k contributions, once converted into a Roth IRA, tax and penalty free immediately like the normal Roth IRA contributions are? Again, the contributions, not the earnings. I ask because I have for several years maxed out my Roth IRA, and am now in the position to max out my 401k (either traditional or Roth). However, I have a strategic decision to make. I am applying to go back to school for a PhD and even with the possibility of grants, scholarships and stipends, there may (likely) still be expenses. If the need arises, and I can use the Roth 401k contributions made this year tax and penalty free, then that is a nice safety net. However, if the whole conversion from Roth 401k to Roth IRA is subject to the 5 year wait, then I don’t see a benefit (for this year) for Roth vs traditional 401k contributions.

  151. Harry says

    Adam – The five-year rule affects earnings and money converted from a traditional account. Neither applies in your case when you are only talking about withdrawing your own contributions, not earnings, not converted money. A rollover from Roth 401k to Roth IRA is not a conversion.

  152. Jeff says

    Adam – just a quick tip, if you don’t plan on working while you’re going back for your PhD, take that time to convert some of you’re traditional 401k holdings over to Roth holdings (i.e. rollover your 401k, then convert 20k or so a year over to your Roth IRA — it’s usually just a matter of asking your broker to journal the funds between accounts). If you won’t be taking a salary, and you don’t have a large source of income from some other source, you can effectively convert the funds tax free (or for a very low rate).

    In some cases like yours, it can even be worth taking the 10% penalty to withdraw the funds (if you have no other options). Imagine you’re currently paying 28% tax on every extra dollar earned (you’re AGI is above 87k), then contributing to a traditional this year saves you 28% in taxes. Suppose you have no income at all for the tax year of 2015 (I’m assuming there would be a year in between where you worked part of the year so had some income), you could 10k tax free (standard deduction + personal exemption) and another 9k at the 10% tax rate, pay another 10% penalty on the whole thing and you’d still only be paying an average of 15% on that 19k of income as opposed to the 28% you’d be paying this year if you don’t contribute it to a traditional 401k plan (including if you did contribute it to a Roth 401k plan).

    The better option is to not withdraw the funds, but simply convert them from traditional to Roth funds 20k at a time. That way you take full advantage of your personal exemption, deduction and 10% tax bracket. You’ll need a thousand dollars in savings to pay the 10% tax on the second half of the conversion, but that’s much less than the $5,600 you’d be paying if you put it into a Roth 401k plan today.

    I live an alternative lifestyle, which involves taking lots of mini “pretirements”. When I work, I save most of what I make and max out my 401k contributions. Then during my “pretirements” I take advantage of my temporarily low tax bracket to convert the money over to roth accounts with minimal tax payments. The trick most people can’t seem to stomach is living on 20% of your income when you have one. I’ve never understood normal people…

  153. Adam says

    @Harry Thank you. I figured that was the case, I just couldn’t find a specific example of doing so.

    @Jeff That idea makes a lot of sense. Since I have other sources of liquid funds I can tap for some expenses and taxes, I think that I’ll make full use of my lower tax bracket to convert some of my traditional holdings to Roth. And, since I’m going that route, to just make traditional 401k contributions this year and save the several thousand in taxes and only pay taxes/penalties if I need to later.

  154. William says

    It strikes me that the question is really one of effective tax rates, not marginal tax rates. So, if you assume the tax code remains unchanged (which though certainly unlikely to be true, is probably the most conservative approach), a Roth 401(k) is better than a traditional 401(k) if you effective tax rate is lower while investing than in retirement.

    Marginal tax rates are irrelevant. They are just an input into the calculation and the entire discussion of high marginal rates going in and low marginal rates coming out is misleading.

    If this is incorrect, I would really like to hear why.

  155. Harry says

    William – It’s still about the marginal rate, but not necessarily the marginal rate for the very last dollar. We can call it “effective marginal rate” if you’d like to put it that way.

    At the time of contributing, the money comes off from the top. If it spans multiple marginal rate brackets, then you get a weighted average marginal rate for your contributions. If you are contributing as Roth 401k, that weighted average marginal rate is the rate of tax savings you are giving up. It’s not your effective tax rate taking into account your entire income, just the portion you are contributing into the 401k.

    After you retire, if you have other income (pension, Social Security, etc.), your withdrawal from a traditional 401k goes on top of those. If it spans multiple marginal rate brackets, then you get a weighted average marginal rate for your withdrawal. If you contributed as traditional 401k, that weighted average marginal rate is the rate you will pay. It’s not your effective tax rate taking into account all your retirement income, just the portion you are withdrawing from the 401k.

    If you have no other income in retirement, the “effective marginal rate” is the same as your effective rate. You do have other income when you are contributing. The “effective marginal rate” when you are contributing certainly isn’t the same as your effective rate.

  156. Andrew says

    Harry- I am a 34 year old cardiologist in California, just beginning my career. my salary puts me in the 33% tax bracket and I can expect only a modest increase through my career, possibly into the 35% bracket (but not by much) I work for a large healthcare organization with excellent benefits including a pension which gives me 2% a year x 20 years and 1% thereafter, and a set contribution from my organization into a 401(k) of about $20K per year (this is not a “matching” contribution). I can choose to contribute on my own to a traditional or Roth 401(k). I do not plan to retire outside of California (but who knows) and I don’t care much about my “estate.”

    – Given my company already contributes to a traditional 401(k) for me, should I contribute on my own to the Roth to achieve better tax diversification?
    – Given I have a pension plan which will likely give me at least $100k/year in retirement which would boost me into a higher tax bracket than someone without this benefit, should this push me more towards the Roth?
    – The ability to convert a traditional to a Roth (but not vice versa) is appealing. Why don’t more people take a job at Starbucks for a year before retirement and convert while they’re in a lower tax bracket?

    • Harry says

      Yes having a pension and employer contributions to the traditional 401k favor Roth contributions, but if there are chances you will retire early before the pension kicks in, you will still have years to convert those traditional balances to Roth when you have little income. Working at Starbucks isn’t necessary. Just going fishing (or hiking, bicycling, volunteering, …) will do.

    • FinancialDave says

      I admit I did not read all 171 comments to this thread, but the theme is pretty clear. There are seemingly a lot of people, some of which are probably advising others that just don’t get the fact that given identical tax situations for the money going into the account as coming out later in retirement there is NO mathematical advantage to one plan over the other. The author uses many terms such as the Commutative Law of Multiplication and marginal tax rates that just tend to confuse people, but let’s just reword it to say if the average tax rate going in is the same as the average tax rate going out, there is no advantage.

      AND let’s be fair if we could predict our future tax rates with any degree of accuracy we could make the right decision, but despite what anyone thinks, Congress CAN totally mess you up in just a few short years, so give up trying to guess one way or the other and just split the allocation in some reasonable way — 40/60, 50/50, or 60/40. I believe you will have a much nicer retirement.


  157. FinancialDave says

    I also agree with the author that by contributing to the 401k you do lower your income and “possibly” become available for some tax credits, but you must also remember the other end of the spectrum in retirement — A large non-Roth 401k or IRA is going to create higher taxes when the forced RMD’s kick-in and on this end of timeline you could be looking at going from paying no tax on your SS to being taxed on 85% of it.


    • JJackson says

      Fd…can you elaborate on your point of no mathematical advantage to Roth money versus Traditional money? There very clearly is an advantage, and it has nothing to do with estimating future tax rates, which is near-impossible.

      Let’s assume you make $100k and are in the 25% bracket today. You decide to contribute $10k to a traditional 401k. Thus, only $90k of your income gets taxed (not taking into consideration any other deductions or credits). Since the $10k contribution is saved tax-free today, you are effectively saving $2500 in taxes (otherwise would have paid 25% tax on that $10k in income.

      Or, you could contribute $10k to the Roth. You would pay your tax rate of 25% today on this contribution, as it would be included with the rest of your income.

      So, Traditional 401k saves you $2500 today versus a Roth.

      Now, let’s just assume for illustration purposes tax rates do not change at all (if you know for sure which way they are heading and what your tax rate will be upon retirement, there are additional benefits in going with either Roth vs Traditional). So, upon retirement, you are still at the 25% rate.

      Then let’s assume you invested your $10k well and over 30 years you turned it into $100k. (This is not unreasonable, and would take an 8% annualized return to achieve.) If we compare both options, Traditional versus Roth, you’ll see a dramatically different outcome. If we withdraw our $100k out of the Traditional plan, it is ALL considered income. So, now your tax bill is $25,000 (25% tax rate and $100,000 of income) at time of retirement. Contrarily, if we withdraw our $100k out of the Roth plan, it is ALL withdrawn tax-free. Meaning at time of withdrawal, you pay nothing at all in taxes.

      So, with the Traditional 401k you pay $25,000 in total taxes (taxed at time of withdrawal). With the Roth 401k, you pay $2500 in total taxes (taxed at time of contribution). Very big difference. In this particular example, you pay ten times as much to Uncle Sam if you go with the Traditional approach.

      If you have time on your side or reasonable expectation of performing well in the market and actually growing your money, Roth is VERY attractive. With the above example, you can see this clearly. It’s amazing how often people don’t consider the power of compounding returns when they think about Traditional versus Roth. Don’t make this mistake.

    • William says

      Just to point out a mistake in the math. At a 25% tax rate, it would take $13,333 of taxable income to put $10,000 in a Roth. So the present tax hit is not $2,500, it’s $3,333. Still, I’ll grant you that the last I checked $25,000 is a bigger number than $3,333.

    • Steve says

      Just to point out something you’re missing while comparing the two: You have to assume that the extra $3,333 it would take to invest 10k in a Roth vs traditional would also be invested and getting the same returns. You then can compare the value of $10k in a Roth versus $13,333 in a taxable account after 30 years or whatever. If you do this, you will see that (assuming a 25% tax bracket at both ends) the difference is negligible (~$30).

  158. JJackson says

    You’re absolutely right – elementary math mistake on my part that I’ll blame on distraction by responding via iPhone on a train on the way home from work. ; ) Thanks for the correction.

    But yes, the argument still stands. Point is, saving for the future is all about earnings, and if it isn’t in your eyes then you’re making an enormously costly mistake whether you consider taxes or not. When you do consider taxes, and earnings from each type of retirement account are considered, there is a clear, after-tax winner. Roth.

  159. FinancialDave says

    I can link you to my website where I explain it in the simplest terms I know how with a very simple example:

    The shorter answer to your question is that you have to consider the amount of money you earn, not only the amount that goes in the Roth — in the case of the Roth the taxman is compounding your money for 30 years and keeping the gains, while in the case of an IRA you are compounding the gains and then giving the taxman his cut at the end of the period. The taxman’s cut is the same in either case and the amount of money you have at the end exactly the same.


    • JJackson says

      I see your point and the approach you’re taking. I suppose I’m coming from the angle of not wanting to give the IRS the benefit of my (hopefully) strong investment performance. Just like you said in the example on your link, you’re really doing the taxman a big favor if you delay the tax until AFTER you’ve made all your money. You’re effectively passing on your strong investment management skills to the IRS for free. The government is likely not making investments that yield 8%+ per year, as you may be able to obtain, as they won’t take the inherent short-term risks of doing this. Therefore, if you go with a Traditional/tax-deferred retirement plan, they are capitalizing on you taking risk on their behalf and giving them much more money after all is said and done than they would have had had you paid the 25% up front in a Roth option.

      The rate is the same either way – either way you’re paying the IRS the same share, the same 25%, whether now or 50 years from now – but, if we are looking at it from an actual dollars standpoint, which is what really matters when it comes down to it, I’d much rather give someone 25% of a smaller sum rather than a larger sum. For example, going to the extreme just to illustrate, would you rather give someone 25% of $1 today, or 25% of $1,000,000 a year from now?

  160. KildareBill says

    Financial Dave-

    I think you are missing an important point in your comparison between ROTH and non-ROTH accounts. If you choose and can afford to contribute the maximum amount to your account, the ROTH has a significant advantage. In order to compare to your example, let’s assume that $7,500 is the maximum allowable contribution.

    With the ROTH, to contribute $7,500 you start with $10,000 income and pay $2,500 in taxes up front. After 20 years, the ROTH will be worth $50,456, as your example showed.

    With the non-ROTH, you contribute $7,500 and you save $1,875 (25%) in taxes. To compare with the $10,000 income from the ROTH, you end up with $625 ($10,000 – $7,500 -$1,875 = $625) of taxable income. Paying 25% taxes ($156) leaves you with another $469 to invest. Of the $10,000 income, $7,500 went to non-ROTH, $156 went to taxes and $2,344 is left to be invested outside of tax-deferred account.

    This $2,344 can be invested at an after tax rate of 7.5% (10% return less 25% taxes). After 20 years this will be worth $9,957. After 20 years the non-ROTH will be worth the same $50,456 as the ROTH. However, you must pay $12,614 (25%) in taxes leaving $37,842. Adding this to the $9,957 gives you a total balance of $47,799 for the non-ROTH.

    In this example the ROTH enjoys a $2,657 or 5.6% advantage over the non-ROTH.

    Also note that if you extend this to 30 rather than 20 years, the ROTH advantage exceeds 10%. Also note that if your tax rate is 30% (including state) rather than 25% and extends over 30 years, the ROTH advantage is 15%.

    The ROTH advantage when you contribute the maximum amount is real and significant.

    • FinancialDave says

      I understand your point, but it only compares apples to oranges and does not compare the Roth / non-Roth investments on equal footing. You are comparing a $10,000 investment in the Roth to a $7500 investment in the non-Roth, with a $2500 adder in a taxable account. Of course the $10,000 tax-free investment wins over a $7500 tax-deferred plus $2500 taxable investment.

      By your logic then if the tax limit on the Roth is $20,000 and the tax limit on the IRA is only $10,000 if you earn $26,667, then you should invest the total after tax $20,000 into the Roth account because that will give you more money in retirement.

      This is just bad tax planning and a waste of your money, for reasons I point out on my website.

      What if by investing equal amounts in both accounts you could take not only the tax-free money and gains on the $10,000 Roth investment, but you could take completely tax-free money and gains on the non-Roth money as well — for which the taxman got ZERO taxes (none going in and none going out).

      The result is your scheme cost you $26,667 to get the same gain that I got for $23,333, because I was able to actually adjust my tax rate to a lower level (zero in this case) which thus made the IRA funds much more valuable.

      This is not some dream as I see evidence every year when I do taxes for retirees and they have all kinds of tax-free income, that had to have cost them dearly while they were working, but now don’t have enough taxable income to even equal their deductions and exemptions, which for a married couple can amount to $30k of tax-free income. If they had something like a tax-deferred IRA or even a taxable account they could be pulling money out on a tax free basis. This is the flexibility that having both Roth and non-Roth funds gives you, so stop trying to compare apples to oranges and realize that the money streams are equal given the same earnings and taxes on both ends and realize you need both types for your best chance at lowering your lifelong taxes.


  161. Joel Berry says

    In this example you can make all the predictions, assumptions, and proposals you want, but that has more value as confetti than anything. There are TWO facts that should make this simple for nearly everyone.

    1st. 90% of the population will not have saved enough when they retire, therefore most people (90%) need to use the tax savings from a traditional IRA or 401K to increase their contribution. “A bird in the hand is better than two in the bush.” IF YOU DO NOT UNDERSTAND WHAT THIS MEANS HAVE SOMEONE EXPLAIN IT TO YOU.

    2nd. No one knows the future! If you can tell me what Tax rates will be in 20 years, what your income will be, what investment will turn out the best, then this is the least of your concerns. AGAIN “A BIRD IN THE HAND…”.

    • FinancialDave says

      You are very close to getting it yet you contradict yourself, when you say you can’t predict future taxes yet you suggest a strategy that is based on one particular tax scenario.

      If 90% of the population is under saving their one hope of having more than the next person over their lifetime, given the same investments, is that they give less to the taxman over their lifetime.

      It would be sad indeed (except for the taxman) if someone followed your strategy and then found out in retirement because of RMD’s and other factors that they had to pay twice the tax rate on their money than was expected.


  162. KildareBill says


    I believe you misread my post. I did compare apples to apples with $7,500 invested in ROTH and non-ROTH.

    Let’s face it, the vast majority of the people following this are not the 90% who won’t have enough to retire. They are the 10% who will be adequately funded and will likely not be in a low tax bracket in retirement. They are reading this to determine the best place to put their retirement dollars.

    For the majority of people who will not fully fund their retirement and won’t have significant income during retirement, your recommendations make sense. But for those of us who try to max out our retirement contributions and anticipate being in a higher tax bracket in retirement, the ROTH is a clear winner under most scenarios.

  163. John Navarre says

    Would these same arguments apply to the discussion of Traditional Deductable IRA vs Roth IRA? If not, why not?

  164. EL @ Moneywatch101 says

    I always wondered why people jump into financial fads before doing any real tax research. Once you contribute the full match on the traditional 401K, is this case against ROTH 401K, also in conjunction with not contributing to a regular Roth IRA? I know it varies on the person, but for diversification of investable assets do you feel it will benefit people to do 6% in traditional 401Ks, and then if they have enough to max out the regular Roth IRA?

    • Harry Sit says

      See reply right above yours. All arguments against the Roth 401k also apply to the Roth IRA when you are not yet contributing the maximum to your traditional 401k. An argument in favor of the Roth IRA is that some 401k plans have higher fees. Even then the traditional 401k can still be better when you don’t expect to work there for many years. You can roll over to your own traditional IRA when you change jobs.

  165. David Heinrich says

    I think it is worth noting that one point in favor of a Roth IRA is that they don’t have RMDs during the lifetime of the account holder and can thus be quite valuable to the heirs. This is where the benefits of these accounts become huge.

    • Harry Sit says

      If you don’t want RMD, you can convert to Roth at any time. Picking a time to convert to Roth on your own schedule gives you more flexibility than contributing to Roth up front. I listed some of those opportune times under #3.

    • David Heinrich says

      Right, you can convert on your own schedule, but that’s more likely to possibly bump you up a tax bracket, depending on how far apart you can stretch the conversions.

      Also, people are unlikely to take those big tax hits and do conversions. It is a psychological road-block.

      The real issue is whether it makes sense to contribute steadily to a Roth year after year, versus contributing to a traditional year-after-year, then converting large amounts of money and paying the taxes on those conversions over 1, 3, 5, 10 years.

      Also, if you think tax rates are likely to go up when you may have an opportune time to convert, those opportune times become less opportune.

  166. David Heinrich says

    On the other hand, an advantage of Traditional IRAs for those who can afford to donate to charity is the possibility of the Qualified Charitable Distribution and IRA Charitable Rollover. However, looking ahead 10, 20, 30 years, that’s an enormous “if”, as it seems like this expires every year and is then reinstated (not yet in 2014).

  167. Mitch says

    Wow… I actually read all the responses to this great article… and even discovered I had posted one a few years ago (#151).

    I’m still flabbergasted how people continually aren’t comparing apples to apples… but let’s move beyond that…

    In the end, I think the die-hard analysts and tax planners that are browsing this thread shall not have much to worry about in retirement. “Do I have a side salad or an order of broccoli tonight?” Both are healthy options… just don’t get the fried chicken…

    While I had initially understood the Roth to be a great vehicle upon graduating college, especially in lower tax situations, I think there’s definitely something to be said for “delaying taxes”. For instance, I live in VA. If I move to say Florida or Texas or Nevada to retire, avoiding that 5.75% VA income tax with a traditional 401k may prove to be worthwhile.

    Conversely, if I were already living in a no-income-tax-state today, I’d be more inclined to do a roth…

    As has been widely debated, who knows what Congress may decide to do. Yea, perhaps brackets change and marginal rates go up… but what if Congress decides to start taxing Roth vehicles? Please don’t be so naive to say “they can’t do that!” Look at the health care bill that was passed… It’s anyone’s guess what the future may bring…

    And going back to my original post where I was calculating what current day income would put me in an “average rate” of my current 28% marginal bracket… that was well over $300,000… For those of you that aren’t understanding the math… Because I’m not having to pay taxes at roth levels while I’m earning today (28%), in order to have a cost of said 28% when I retire and withdraw from my traditional-401 (assume I’m already retired today), I’d need to be withdrawing over $300K+ for income… and I can tell you that is _well_ above what I make. 🙂 Sounds like a good problem to worry about… and as someone that is only 31, I have a few decades to ponder it and find a good tax guy to pay to help me do that if need be…

    Keep the thread running!


  168. ken says

    You make a formidable argument until the subject of the”company match” comes into play. If a company is willing to match 4,5,6 %, that is free money of which will NEVER be taxed within a Roth 401k. This match would however be taxed in a traditional upon withdrawl. End of story. Makes no sense at any income bracket if any significant match is in play.
    Ken-Morgan Stanley

    • Harry Sit says

      You say you work at Morgan Stanley but you don’t know that the match goes into Traditional 401k regardless? Check with your training department.

  169. brendon says

    Thank you for the thread. I know deferred taxation topics well, but recently my company began offering a Roth 401(k) in additional to the Traditional. As I have a fairly large traditional 401(k) balance after 20 years on the job, I began worrying about the RMDs and if I should diversify.

    This original article – and many of the comments – have helped me think through that problem, and decide to take my tax break now (in a high income tax state).

  170. DD says

    I have an S corp with me and my spouse as the only employees. Due to a good business year, personally we’ll likely be in the highest tax bracket this year. I want to save on taxes and put away a lot to retirement. For each of us, we can take a salary of $140K which allows us to put $18K deferred in a 401K (or a Roth 401K) and the other $35K as profit sharing (25% of $140K) for a total of $53K each or a total of $106K to the 401K’s for both of us. That’s all a tax write-off. I’m trying to decide whether it makes sense to do this, or if I should just pay myself more thru profit distributions and possibly wages (and my spouse nothing) to save the social security taxes on her wages (12.4% up to $118,500 =$14,694 in 2015). I think it does make sense to pay her and pay the social security taxes given the tax savings on that $53K of her income we’re deferring by putting it in the 401K , but my other dilemna is whether it makes sense to pay her that $140K and then choose the Roth IRA option for her $18K “deferral” which isn’t really a deferral since it’s taxed. Seems like I’m paying the extra 12.4% this year and not getting any tax benefit on that $18K going to the Roth this year. I like the idea of the Roth but I can’t figure out the math. And I’m of the opinion that taxes will likely be higher in 30 years when I retire due to government spending and lack of retirement savings by the average person.

    • Harry Sit says

      I think it’s better to keep your salaries in line with comparable jobs as the IRS requires. If the increase in income is only temporary, it makes more sense to use the traditional 401k.

  171. Luke says

    This articles a little old now, but I found it very refreshing compared to other Traditional 401(k) vs Roth 401(k) articles out there.

    I’ve read most of the back and forth comments and I’m pretty convinced of TFB’s arguments.

    What I’m REALLY confused about though, is how some online calculators seem to spit out numbers that make Roth 401(k) almost always better than Traditional 401(k).


    The only way I can make that calculator show Traditional 401(k) as better is if the Current Tax Rate is MUCH higher than the Retirement Tax Rate. As in the Current Tax Rate has to be at least 8% higher than the Retirement Tax rate.

    So for example, I’m in the 28% tax bracket right now and according to that calculator, a Traditional 401(k) would only make sense if my retirement tax bracket was at 15%. I’d have to take less than 38% of my current income in retirement to get that low!

    Is that calculator accurate, or based on some flawed assumptions?

  172. Jim says

    I was one of those who invested early and at a high percentage in a 401k/TIRA with little chance to invest in any Roth. I am reaping the benefits of a large TIRA to go along with a nice pension and soon to collect SS at age 70.

    RMDs for the most part won’t be needed to fund retirement expenses but will likely push me into a higher tax bracket during a hopefully long retirement. While I loved the tax deduction of my T401k contributions I now wish I had had the opportunity to put say 1/4 of those contributions into a Roth 401k. I know you can’t have it both ways but sometimes a bit of both can make some sense – retirement often lasts as long as your working years.

  173. Phillip Henry says

    I’m young and intelligent enough to see what our economy and debt has exploded to since this original post. Looking at the history of the marginal tax rate, we are in one of the lowest taxable periods ever. I’m not a fortune teller but tax rates will be higher in the future. Why would I want to defer my low taxable amount to pull out during a higher time. Who assumes that you will be in a lower tax bracket in retirement. I hope I’m not in a lower tax bracket, that means I wasn’t successful in life. Plus, look at all the tax credits you lose: children are all grown up, hopefully your mortgage is paid off, you probably sold your business since your retired. Most importantly, yes your money grows tax deferred, but who else is enjoying in that growth…. Uncle Sam. Uncle Sam is your business partner that didn’t contribute anything but will expect his cut. I look to diminish his cut. I have three buckets, taxable, tax deferred, and tax free. By having these 3 buckets, to include ss benefits, I can optimally avoid paying majority of the taxes, that this post will force Americans to do. Keep drinking the Kool-Aid

  174. Eric says

    Excellent article, both well reasoned and presented.

    Paying marginal rates now vs filling up the tax brackets later pretty much is the crux of why traditional is vastly superior over Roth for just about everybody. NOT everybody, but close.

    There is another aspect to this discussion that I don’t see mentioned. The advice to put money in Roth when young and t/IRA when older hinges on the assumption that the young earner will have years of similar if not higher annual disposable income as they age. That might be true but it is not likely. To see why, we can start with 50% of marriages ending in divorce, and continue with out-sourcing, illness, disability, periods of unemployment, college tuitions, children and a gazillion other expenses that present themselves in later years.

    We don’t know what the schema of progressive future taxation will look like but the 2016 standard deduction and personal exemptions for a married couple are ~ $20k today and are likely to stay the same in real (2016) terms. Since retirement can easily last 25 years it follows that the first ~ $500,000 of t/IRA savings are tax FREE and the next $500,000 of t/IRA savings are in the 10% tax bracket if no other income streams are present. Roth contributors at a young age are counting their shaved eggs waaay before they hatch. This is not just a case of having to make plans and choices at a young age; Electing Roth is often just a case of not considering the uncertainty in our society and workplace.

    Last comment, social security really should be considered. I cooked up a simple spreadsheet to calculate federal taxes for a married couple in retirement with mixed income streams here:

    My prototypical example is $62k of 2016 dollar income from $36k SS and $26K savings results in a federal tax liability of $1130.00. Taxes of the SS would be zero if it was the only income stream so the tax rate on the t/IRA works out to 1130/26000, equal to 4.3%

    Tell me again why people are paying marginal tax rates today for a Roth ?

    Cheers — Eric

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