This post follows a previous one that I made on the basics of Traditional and Roth IRAs, in which I explained and modeled out the benefits of using a Traditional or a Roth IRA (versus a taxable investment account). After reading a post on Reddit about the benefits of Roth accounts, I actually took away the other conclusion - I was too gung-ho on Roth accounts, and that the traditional 401(k)/IRA deserved more credit than I gave it. This post elaborates a bit more on the Roth vs. Traditional decision (for both IRAs and 401(k)s) - and why perhaps the answer is most likely “a bit of both”.

why I still love roth accounts

To be clear, I walked into that post fully expecting a big dose of You’re Right! to feed my confirmation bias. The Roth is a more clear-cut case of guaranteed benefits versus a taxable account; you’re not paying any capital gains taxes and therefore sure to come out ahead. Plus, the Roth accounts were more powerful in their capacity to shield money from taxes - a post-tax dollar is inherently more money than a pre-tax dollar. I expect to land in the top tax bracket during retirement, hence there was no point in bothering with a traditional retirement account where any dollars I put in now could very possibly be withdrawn at a top marginal tax rate of around 35-40% (and perhaps even higher, depending on how government policies shift decades from now).

filling lower tax brackets during retirement

In short: my revelation on the value of the Traditional IRA/401(k) was around the fact that in retirement, if I wasn’t recognizing income I was missing an opportunity to pay lower tax rates. Suppose I had $5M in Roth accounts when I decided to retire and wanted to pull $200K annually from my accounts - I wouldn’t have any taxable income to report thanks to the origin of the money - a Roth account - and so I wouldn’t owe any taxes on that money. But note that the money I had contributed to the Roth account was post-tax money; perhaps the bulk of that money was contributed at a marginal tax rate of 30% or higher.

In contrast, imagine now that I had $3M in Roth accounts and $2M in Traditional accounts when I retired. I decide to pull $120K annually from my Roth accounts and the remaining $80K from my Traditional accounts. Now, I’m reporting my annual income is $80K during retirement, which I pay taxes on - but in all due likelihood my income is getting taxed much lower, thanks to filling up the lower tax brackets. I’m not exactly able to net out a full $80K; but contributing enough money to end up with $3M in a Roth account (using post-tax dollars) and $2M in a Traditional account (using pre-tax dollars) is substantially easier than contributing enough post-tax dollars for $5M in a Roth.

For the sake of argument, suppose that in order to net out a full $80K after withdrawing from a Traditional account and paying income taxes, I’d need to withdraw $100K from the account (in other words, I’m paying 20% income tax, on average) and that in turn I’d need $2.5M in my Traditional account upon retirement. I’d need to save up during my working years to have $3M in a Roth and $2.5M in a Traditional account. Noting my earlier assumption of 30% marginal tax rates for income during my working years, the Roth-only option is more difficult to reach than a combined Traditional/Roth split.

in conclusion

Roth retirement accounts are great - but they’re not so great that you should be fully gung-ho on using them (and only them) when it comes to saving for retirement. If you’re expecting future marginal income tax rates (in retirement) to be lower than what you’re paying today, the Traditional accounts merit a close look.

My strategy today of using only Roth accounts for my 401(k) and IRA won’t change yet, as I don’t think my marginal tax rates are so high yet to make the Traditional route more tax-optimal. However, in a future where I’m earning significantly more, I could see myself leveraging a backdoor Roth IRA (since Traditional IRAs have income limits on who can deduct contributions) and a mix of Traditional and Roth 401(k)s at work, including the mega-backdoor Roth 401(k).

I am not providing or intending to provide tax, legal, or accounting advice. This blog post is for informational purposes only, so please don’t rely on it for tax, legal or accounting advice. Consult your own tax, legal and accounting advisors before engaging in any transaction. I’m just a guy on the internet. Please don’t sue me.