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His Royal Hiney |
Keystoner
I don't think your mission is stupid and I'm not patronizing. You're an engineer and you play with numbers. I do the same. Artists probably make pencil sketches and poets write verses.
The claim isn't stupid. I backed into it as part of my analysis. And I even said, "So it appears the saying is true mathematically."
This is a key divergence between the "claim" and your interpretation of the claim. It's not about "equal contributions to a Roth and a 401k;" it's about equal out-of-pocket, net-of-tax contributions to a Roth and a 401k. I am asking you to view the issue from a real world perspective: balancing retirement savings against immediate living expenses. You want to save as much as you reasonably can for retirement, while still covering your current and near-term expenses. The more you allocate toward retirement, the less you have for today's needs -- but the less you save, the more insecure your retirement could be. That's the fundamental tradeoff. Let's assume you want $70,000 available for current, non-retirement spending from the income of $100,000. * If you contribute $5,000 to a Roth IRA, you're doing so with after-tax dollars. Assuming a 25% effective tax rate, you'll pay $25,000 in taxes leaving you with $70,000 in spendable income. Your out-of-pocket contribution is the full $5,000 - it came from money that would have went into your pocket and could have otherwise spent. * If instead you contribute $5,000 to a traditional 401(k), that contribution is pre-tax. Your taxable income drops to $95,000, so your tax bill is reduced to $23,750. That leaves you with $71,250 for spending. Because you still have $1,250 more in spendable money in your pocket than in the Roth scenario, your real out-of-pocket cost for the 401(k) contribution is only $3,750. So while the contribution amounts may look equal on paper, the cost to you -- in terms of money you can't spend today -- is not equal. That's what "equal out-of-pocket, net-of-tax contributions is getting at. * To get an "equal out-of-pocket, net-of-tax contribution amount, you would need to contribute $6,666.67 to the 401(k). That reduces your taxable income to $93,333.33 at a 25% tax rate, your tax bill is $23,333.33 -- leaving you with $70,000 in your pocket as spendable income, just like in the Roth scenario. So even though you're giving up the same $5,000 of current spending income in both cases, the 401(k) ends up with $6,666.67, while the Roth has only $5,000. That's why it's misleading to compare equal contribution amounts without adjusting for taxes - the real cost to you isn't the same. The reason I lay it out this way is because this is the correct interpretation of the claim. When you compare the net future value of both accounts -- using equal-out-of-pocket, net-of-tax contributions -- the results align perfectly with the claim. * A $6,666.67 contribution to a 401(k) compounds to $301,728.37. A 25% tax is $75,432.09 leaving you with a net of $226,296.28. * A $5,000 Roth contribution (same out-of-pocket cost) compounds to $226,296.28 - with no taxes due. So both paths result in the same net retirement value, despite different contribution amounts - precisely because they started with the same real cost to you today. And because this approach achieves the claim -- if the tax is the same in the future, a 401(k) is the same as a Roth IRA -- it serves as proof that the reasoning is sound. Q.E.D. "It did not really matter what we expected from life, but rather what life expected from us. We needed to stop asking about the meaning of life, and instead to think of ourselves as those who were being questioned by life – daily and hourly. Our answer must consist not in talk and meditation, but in right action and in right conduct. Life ultimately means taking the responsibility to find the right answer to its problems and to fulfill the tasks which it constantly sets for each individual." Viktor Frankl, Man's Search for Meaning, 1946. | |||
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| That is my spot. |
Repeating!!!! If you use your above (correct imo) math and logic, the choice between the two options comes down to what you think your FUTURE income tax burden will look like. Will your effective tax rate be higher at withdrawal (because you do not have to be retired to withdraw) or lower? Ask your crystal ball. ***************** Those who would give up essential liberty to purchase a little temporary safety deserve neither liberty nor safety. - Ben Franklin | |||
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Member |
Rey HRH, Yes, you’ve identified the crux of our disagreement, the interpretation of the claim. Real world perspective? Ray: Hey Frank, I just went to the Roth store and bought $5,000 worth of gold. Frank: Oh, I think I’ll go to the 401(k) store and buy $6,667 worth of gold. Ray: No, you can’t, you can only buy $5,000, just like me. It’s the rule. Frank: But that wouldn’t be a fair comparison. Look, I just want to be able to contribute the amount that brings us both to the same position after we pay taxes. Rey HRH: Frank’s right. It's not about equal contributions to a Roth and a 401(k). It's about equal out-of-pocket, net-of-tax contributions to a Roth and a 401(k). Keystoner: I see what you’re saying, and if that’s what the claim intended, you’re right. Year V | |||
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| Ignored facts still exist |
So I ran through some numbers showing what you would get when comparing the following: 1] 401k 2] Taxable (after tax) account Yes, 401k wins, but if you compare the 15% long term cap gains in the taxable account to the higher "as income" that you pay when you withdraw from a 401k, the difference isn't astronomical. I thought there would be a larger difference. Yes, I made the assumption that gains in the after tax account were long term. It was a SWAG. . | |||
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| No More Mr. Nice Guy |
Just gonna say that such a portfolio that only has long term capital gains would be incredibly bad as a retirement vehicle! It may not even be possible to find stocks, funds, or other investments which never create short term capital gains, nor any dividends, nor interest. Especially over a period of decades. But if you did, it would not be diversified. It would be subject to market swings which may conflict with the owner's timing for needing cash. "Sequence of Returns" risk would be very high. | |||
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