quote:

Originally posted by Fly-Sig:
This specifically is where you are wrong:

quote:

Originally posted by Keystoner:
"If the tax is the same in the future, a 401(k) is the same as a Roth IRA," right? I read that here over 10 years ago. Someone posted an equation "proving" it. It has bothered me ever since. I thought it was a simplification. I knew it was flawed.

Claim: If the tax rate is the same in the future as it is now, a 401(k) is the same as a Roth IRA. (Basically the claim is, in the end, you pay the same amount of taxes and the value of the investments will be the same.)

This is your claim also. You said it right here:

quote:

Originally posted by Fly-Sig:
Multiplication is commutative, so it does not matter if taxes are taken first or last in the equation, only whether that tax rate is the same.

My claim: It’s not true.

I proved it. To be sure, tax rates matter, but if they’re the same, the Roth is better in the end. (In my original example, the tax rate in the future would have to come down to 20.1% for the two vehicles to be the same.)

quote:

Originally posted by Fly-Sig:
You have played cutesy games with when and where you get the $ to pay the taxes, and not correctly accounted for it. I clearly see what you are doing with the math. You are using multiple different ways of calculating and then claiming it proves something wrong, when all it proves is that you are not comparing same to same.

You've concocted a system to pay for future 401k taxes outside of 5he 401k using post-tax dollars invested in a taxable account.

Cutesy? Concocted? I’m not comparing same to same? You clearly see the math?
You don’t understand the math. You don’t understand taxes. But you know the commutative property, so I believe you can understand the math.

You like to use equations, and that’s fine. I’m an engineer. I love solving problems algebraically before using actual numbers. I’ve understood exactly why you keep using the same equations since your very first post in this thread. What’s frustrating is that you’re still using them now after I have been debunking them since my very first response to you. Your equations become more clearly wrong when you try to substitute numbers in them. Look what happened with the gold and art guy. Oh, you were rushing? Well I’m taking my time and maybe you should too so you can prove you understand my thesis and show why it’s wrong. But I’m still patient here.

Skins is right, you don’t need a spreadsheet for any of this. The math is basic but a spreadsheet is fun to play “what if?”

Fly-Sig, you’ve anchored to this since your first post in the thread:

quote:

Originally posted by Fly-Sig:
Gold guy: Net ending spendable dollars = (Initial total dollars) * (1 - % earlier tax rate) * Gain.
Art guy: Net ending spendable dollars = (Initial total dollars) * Gain * (1 - % later tax rate)

Gold guy = Roth
Art guy = 401(k)

Yep, commutative. Net ending spendable dollars is the same for both. It’s not right.

‘Initial total dollars’ appears in both equations, but for the Roth guy, you insist on reducing it by the tax rate (1-% earlier tax rate), so that the initial investment is different than the 401(k). You tried to do this in the beginning by limiting the Roth contribution to $3,750, and you continue to write this equation up until now.

That’s not what happens. The gold bar shop took $5,000 and they couldn’t care less about the tax I owed on my income. I’m holding that gold bar, and at some point, later it’s value doubles to $10,000. It didn’t double to ($5000)*(1-0.25)*2 = $7,500, did it? Someone gave me $10,000 for it. See what happens when you actually put numbers into your equations? Vanguard will take my $5,000 just as well.

Let’s go back to my original example at the top of page 1. Now I’ll really be cute.

We have two people, Frank and Ray. They’re twins and they both work at the same factory and make $100,000.

They both decide to invest $5,000 dollars into a retirement account. Frank decides to put $5,000 into a 401(k) and Ray decides to put $5,000 into a Roth IRA. Neither one of them has paid taxes yet. They just make the deposit into the retirement account from their paychecks.

At the end of the year, the tax bill comes. The tax rate is 25%. Frank’s taxable income is $95,000 because he got a deduction for his 401(k) contribution. He pays: 0.25 x $95,000 = $23,750. Ray has to pay tax on all of his income. He pays: 0.25 x $100,000 = $25,000.

Forty years pass and they did pretty good on their investments. They both had a rate of return of 10% compounded annually. They now have a balance of $5,000 x (1+0.1)^40 = $226,296 in their retirement accounts.

They both decide to withdraw all their money. Frank knows he will have to pay tax on it but he doesn’t care. He’s happy because, guess what, the tax rate didn’t change. He withdraws his balance and pays Uncle Sam 0.25 x $226,296 = $56,574. Ray doesn’t owe any tax when he withdraws because he already paid tax on what he contributed to the Roth 40 years ago.

Let’s compare net worths for Frank and Ray considering only that one year of income and investment.

Frank [401(k)]: $100,000 - $5,000 - $23,750 + $226,296 - $56,574 = $240,972

Ray [Roth IRA]: $100,000 - $5,000 - $25,000 + $226,296 - $0 = $296,296

Difference: $296,296 - $240,972 = $55,324

That’s how much of a difference it is when you compare apples-to-apples, same gross income, same investment. I tried to close that gap by having Frank invest the $1,250 he saved in taxes into a brokerage account and it still wasn’t enough.

Who would you rather be?

Fly-Sig, if you think I’m looking at it wrong, if I’m being cute, if I’m concocting something, show me. The math is not complicated. I clearly didn’t ignore taxes. If you think I addressed them wrong, show me. If you understand the math so well, show me where I’m wrong.

quote:

Originally posted by sourdough44:
I’ve always operated under the assumption of filling up the 401k first, then Roth IRA, traditional IRA after that if income prevents a full amount in the Roth.

Yep. That's the typical advice for the average person.

Contribute up to your company's max 401k match first (essentially free money), then max out your Roth IRA contributions (unless you make too much to contribute to a Roth, in which case it's often worth exploring doing a backdoor conversion anyway).

Even setting the tax aspects aside, a Roth IRA comes with several powerful positive factors, including:
-No RMDs for you or your spouse
-Can withdraw contributions at any time without penalty (if needed for a financial emergency)
-Distributions don't count as "income" for income-related calculations during retirement, such as Social Security withholdings or Medicare insurance premiums

But every person's situation is different, so what's best for most folks won't necessarily be the best for you specifically.

quote:

Originally posted by sourdough44:
I’m not big on paying taxes today over the ‘potential’ for lower in the future, like conversion from traditional to a Roth IRA.

The prospect of higher taxes in the future makes paying them now, when contributing to a Roth, even more advantageous.

quote:

Originally posted by RogueJSK:

quote:

Originally posted by sourdough44:
I’ve always operated under the assumption of filling up the 401k first, then Roth IRA, traditional IRA after that if income prevents a full amount in the Roth.

Yep. That's the typical advice for the average person.

Contribute up to your company's max 401k match first (essentially free money), then max out your Roth IRA contributions (unless you make too much to contribute to a Roth, in which case it's often worth exploring doing a backdoor conversion anyway).

Even setting the tax aspects aside, a Roth IRA comes with several powerful positive factors, including:
-No RMDs for you or your spouse
-Can withdraw contributions at any time without penalty (if needed for a financial emergency)
-Distributions don't count as "income" for income-related calculations during retirement, such as Social Security withholdings or Medicare insurance premiums

But every person's situation is different, so what's best for most folks won't necessarily be the best for you specifically.

This is my thinking! There was one or two years while I was working that I fully funded my Roth even though I'd be penalized. It was worth paying the penalty to get that money in there and invested.

quote:

Originally posted by Keystoner:

You don’t understand the math. You don’t understand taxes. But you know the commutative property, so I believe you can understand the math.

You like to use equations, and that’s fine. I’m an engineer.

Former electrical engineer here, so yes I do in fact understand the math and the taxes.

There's a reason every single financial professional will say that the only difference between traditional 401k and ROTH is the initial tax rate vs the ending tax. because it is factually correct.

I see exactly what you are doing, and you are mixing various amounts and investment vehicles. You are not accounting for the full costs. You proved nothing. And I will leave it there. Call your financial advisor and ask him to sit with you and explain it, and show you why your math is flawed.

quote:

it's often worth exploring doing a backdoor conversion anyway

Please Splain yourself. I contributed a good chunk of money to a Roth only later to find out I am not eligible


My job dropped the 401k because it was only me and another person using it, they never matched anything anyway. I am not allowed to put money in it on my won.

I did also open a traditional IRA and am mostly investing in Fidelity's funds

I think the best thing that most don't actually consider is simply putting something aside. Anything.

There has to be extra money for beer and lotto tickets, right?

I have access to a Roth 401k and change how much is deposited as needed, but it never goes below the matching amount.

Free money? Sign me up!

When I get my tax refund, I just dump it in a Roth IRA and act as if it never happened.

This thread very clearly demonstrates why I pay someone else to figure all this stuff out for me.

quote:

Former electrical engineer here, so yes I do in fact understand the math and the taxes.

There's a reason every single financial professional will say that the only difference between traditional 401k and ROTH is the initial tax rate vs the ending tax. because it is factually correct.

That’s largely correct. Of course it depends on holding periods and how long the tax-free benefit accrues. There's certainly a place for both types of accounts and it largely depends on when you wish to be taxed. The big problem is that nobody knows what tax rates will be upon withdrawal.

quote:

Originally posted by chellim1:

quote:

Former electrical engineer here, so yes I do in fact understand the math and the taxes.

There's a reason every single financial professional will say that the only difference between traditional 401k and ROTH is the initial tax rate vs the ending tax. because it is factually correct.

That’s largely correct. Of course it depends on holding periods and how long the tax-free benefit accrues. There's certainly a place for both types of accounts and it largely depends on when you wish to be taxed. The big problem is that nobody knows what tax rates will be upon withdrawal.

Seems almost like it might be a good idea to split your eggs into three baskets. Trad/401-k, Roth, and brokerage?

Maybe that way you have ultimate flexibility to chose if you want to draw down monies subject to LT cap gains; tax def/ordinary income; and tax free.

I'm just a dumb electrician, but it seems like to a idiot like me, that the most important thing is that you save something and remain flexible.

quote:

Originally posted by chellim1:

quote:

There's a reason every single financial professional will say that the only difference between traditional 401k and ROTH is the initial tax rate vs the ending tax. because it is factually correct.

That’s largely correct.

It's not merely largely correct. It's 100% correct. There's no dispute with this statement, as written, whatsoever.

quote:

Originally posted by Skins2881:

quote:

Originally posted by chellim1:

quote:

Former electrical engineer here, so yes I do in fact understand the math and the taxes.

There's a reason every single financial professional will say that the only difference between traditional 401k and ROTH is the initial tax rate vs the ending tax. because it is factually correct.

That’s largely correct. Of course it depends on holding periods and how long the tax-free benefit accrues. There's certainly a place for both types of accounts and it largely depends on when you wish to be taxed. The big problem is that nobody knows what tax rates will be upon withdrawal.

Seems almost like it might be a good idea to split your eggs into three baskets. Trad/401-k, Roth, and brokerage?

Maybe that way you have ultimate flexibility to chose if you want to draw down monies subject to LT cap gains; tax def/ordinary income; and tax free.

I'm just a dumb electrician, but it seems like to an idiot like me, that the most important thing is that you save something and remain flexible.

You’re not a dumb electrician at all…
You’ve got it figured out.

I'm just dumb, regardless of vocation. Or avocation.

I only have a 401k (index and bond funds). Retirement is imminent. I'm planning to talk to a financial planner soon. I'm under the impression that I should just stick w/ the 401k at this point. It's hard for me to follow the above and this backdoor stuff with various types of Roths.

Should I be considering moving some of my 401k into a type of Roth (I will be subject to RMDs someday that will likely be larger than my target annual expenses).

Even if one decides to enlist the services of a ‘professional’ it can still be helpful to ask the right questions.

I was listening yesterday while reloading ammo for my son, range 9mm. Since it was interesting, I let it run. The interesting stat was the guy took a block of years for the market, may of been the last 20 years or similar. The point is, he listed the market average over that time, then the average gain for the average investor. The segment was on risk and volatility, referencing recent weeks.

With his data, the ‘average investor’ had a gain of just below 50% of the market itself. Just look at some of the headlines the last few weeks, and the volatility. This is due in part because of emotional actions, trades, and reallocation.

I’m not even camping out on the ‘buy & blindly hold hill’, just that I’ve seen people get worked up over events that are somewhat expected to cause angst in markets. There will be something else in the future, likely life goes on.

Since Fly-Sig has chosen to step away, this is for anyone else who may be lost in the weeds, like SigSentry or flesheatingvirus.

I’ve hit on this several times but let me try a different tack.

The crux of Fly-Sig’s confusion is his treatment of taxes.

He’s trying to apply a sales tax instead of an income tax.

He demonstrates this right here:

quote:

Originally posted by Keystoner:

quote:

Originally posted by Fly-Sig:
You want to invest $5k in a gold bar. That's the sticker price. But you must pay a 25% sales tax. So you have to cough up $6250 in the transaction. $1250 is tax due up front before you can take ownership of the gold bar. You in one way have $5000 invested because that is the value of what you own when the transaction is completed, but that gold bar must increase in value 25% before you are even.

Did you run your own numbers here?

The gold guy: -$5,000 (buy gold bar) - $1,250 (tax) + [Time] + $10,000 (sell doubled in value gold bar) = $3,750

Neither the gold-bar store nor Vanguard collect sales tax. The 25% is an income tax, collected separately. To have $5,000 in hand to buy the bar, you must earn at least $6,667, pay $1,667 income tax, and then deposit the full $5,000. The gold buyer does not need $6,250 in hand when he walks in the store.

quote:

Originally posted by chellim1:

quote:

Former electrical engineer here, so yes I do in fact understand the math and the taxes.

There's a reason every single financial professional will say that the only difference between traditional 401k and ROTH is the initial tax rate vs the ending tax. because it is factually correct.

That’s largely correct. Of course it depends on holding periods and how long the tax-free benefit accrues. There's certainly a place for both types of accounts and it largely depends on when you wish to be taxed. The big problem is that nobody knows what tax rates will be upon withdrawal.

Largely correct, also.

The holding period does not matter at all when we are asking which type of account results in more dollars to spend in retirement, given the identical number of dollars to start. The math is the math on that specific narrow question.

There are a myriad of rules for both kinds of accounts which must be adhered to. And there are associated benefits in retirement or at death for various types of accounts. Things such as taxing social security, availability of types of investments, etc.

The younger worker has no idea what their earnings future will be, further complicating projections. A near-retirement worker may find the marginal tax rate on ROTH conversions too painful.

Some advisors have slick software that can optimize the way retirement money is withdrawn and the timing of social security to avoid the big tax traps and maximize spendable cash. Still, all based on guessing the future. I've not seen anything for people more than say 20 years from retirement that brings the whole complex web of retirement finances together.

The best advice is Pedropcola's back on page 1. Fund them all. Get the full employer match to your 401k, use the ROTH 401k if available, otherwise traditional 401k. Maximize any ROTH IRA contributions, fund a traditional IRA. I'll add the admonitions to start early to harvest the most powerful force in nature - compounding gains, and diversify, diversify, diversify.

I'll simplify it. Match > Roth > Traditional.

That said, you'll end up with traditional if you take a match but the match is free money. Roth is betting the tax rate will be higher when you retire than it is now.

quote:

Fund them all. Get the full employer match to your 401k, use the ROTH 401k if available, otherwise traditional 401k. Maximize any ROTH IRA contributions, fund a traditional IRA. I'll add the admonitions to start early to harvest the most powerful force in nature - compounding gains, and diversify, diversify, diversify.

Yes, yes, yes. Fund them all.

For we know not what a future Congress will do to the taxation of any of them.

quote:

Originally posted by konata88:
I'm just dumb, regardless of vocation. Or avocation.

I only have a 401k (index and bond funds). Retirement is imminent. I'm planning to talk to a financial planner soon. I'm under the impression that I should just stick w/ the 401k at this point. It's hard for me to follow the above and this backdoor stuff with various types of Roths.

Should I be considering moving some of my 401k into a type of Roth (I will be subject to RMDs someday that will likely be larger than my target annual expenses).

Figuring if, when, and how much to ROTH convert can be pretty complicated, especially once you hit 63 yrs old.

First, there are the 5-Year rules. You must have a ROTH account for at least 5 years before withdrawing penalty free. Any conversion, even into a long existing ROTH must sit for 5 years before withdrawal. There are details in those rules, so it can be more nuanced than that, but if you can't meet 5 years before you need the money then you need to look really carefully before starting or converting into a ROTH.

Second, a ROTH conversion gets taxed today, so if you are earning well at the end of your career, it may not make a lot of sense. This is where you need to consider how you will access $ to spend in retirement.

Third, other tax events may come into play. If you might have a profitable gain on selling your home, or you may inherit a traditional IRA. Medicare costs are based on your income 2 years ago.

Good financial advisors can put your numbers into software to optimize your specific situation.

Imho, good advisors really shine in this, much more so than in picking stocks.

There's a problem though in order to fund them all you are phased out of being able to contribute. I can't contribute to a Roth, I didn't have the money to max 401-k and contribute to Roth when I earned less, so I max out my 401-K. I was only able to make one year contribution before I was ineligible to contribute.

We have a Roth 401-k option, but that is just a post tax 401-k so still has RMD, so I don't use that. Plus I'm trying to shave dollars off my marginal tax bracket. What doesn't go into 401-k for me goes to regular old brokerage account.