Comments on The Finance Buff: The Case Against Roth 401(k)

What a great analysis! Glad I found your page. I'v...

2008-06-26T05:42:00.000-07:00

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 http://www.joetaxpayer.com/ss.html
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.
Joe

I think I am one of those exceptions too,I have a ...

2008-06-11T16:42:00.000-07:00

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.

Lee - Thank you for your detailed comments. On the...

2008-04-19T11:01:00.000-07:00

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.

Nice analysis, but I've spent some time thinking a...

2008-04-19T09:22:00.000-07:00

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 :-)

Nice piece of work. I didn't do the math, but deci...

2008-04-02T20:01:00.000-07:00

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 ;-).

i track my tax situation very closely. i should hi...

2008-03-31T22:06:00.000-07:00

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.

I'm so glad someone else has come to this conclusi...

2008-03-31T07:25:00.000-07:00

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.

Are you locked into a one size fits all mentality?...

2008-03-25T09:09:00.000-07:00

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.

@anonymous re: being able to rollover to Roth IRA ...

2008-03-24T15:33:00.000-07:00

@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.

One valuable benefit of the Roth 401(k) is the abi...

2008-03-24T14:12:00.000-07:00

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.

quote: Trust me the math law isn't wrong. You assu...

2008-03-21T09:10:00.000-07:00

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.

Interesting post, TFB.My wife is a teacher and wil...

2008-03-20T22:44:00.000-07:00

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.

Trust me the math law isn't wrong. You assumed the...

2008-03-20T18:20:00.000-07:00

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.

Your commutative math law is wrong becuase it does...

2008-03-20T16:49:00.000-07:00

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.

Roth 401K's were not available when I was working,...

2008-03-20T11:44:00.000-07:00

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.

Paul

With all due respect to Kaye Thomas, the first par...

2008-03-19T23:55:00.000-07:00

With all due respect to Kaye Thomas, the first part of her 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?

I don't agree with this. Kaye Thomas lays out an ...

2008-03-19T23:20:00.000-07:00

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

http://www.fairmark.com/rothira/roth401k/wealth.htm

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.

@Debbie - I agree that Roth is perfect for you.@on...

2008-03-19T10:29:00.000-07:00

@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.

This is one of the best posts I've read in a long ...

2008-03-19T09:57:00.000-07:00

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.

My company began offering the Roth 401(k) in addit...

2008-03-19T09:10:00.000-07:00

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!

Interesting. I love the Roths, but I seem I am on...

2008-03-19T09:01:00.000-07:00

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.