quote:

Originally posted by Keystoner:

quote:

Originally posted by Fly-Sig:

You are specifying 2 different initial investments.

No I'm not. I'm considering the EXACT same initial investment. That's crucial for the comparison. I'm also considering the EXACT same gross income.

quote:

Originally posted by Fly-Sig:

The 401k has no taxes up front, so your cost of contributing is just that $5k.

The ROTH does have tax up front, so the cost of contributing is $5k plus the taxes.

In order to contribute $5,000 to the Roth, I must have earned at least $6,666.67, and in order to contribute $5,000 to the 401(k), I must have earned at least only $5,000.

It's irrelevant.

All I can say is you're looking at it wrong.

You make $X. Out of that you have $Y extra that you want to save, somehow, for retirement. You can stuff $Y cash in your sock drawer. You can buy something "collectible" and put it on a shelf. You can deposit it in a credit union savings account. You can do anything with it.

But unless you put it in a 401k or traditional IRA, you'll first have to pay some income taxes on it.

What you're arguing is you're depositing $5k in one or another type of account, ignoring the up front taxes. You have to pay taxes on the first $95k of your income no matter what in your scenario. It is coming out of that $95k, leaving you with some net spendable dollars. On top of that you have the $5k which you can wholly put into the 401k or you can pay $1,250 taxes and have the remainder to do whatever you please with.

You are in fact ignoring the taxes in your calculations by taking them out of the $95k and then not accounting for them. To be apples to apples, you are using $5000 + $1250 for the ROTH, so you should also calculate based on $6250 deposited into the 401k.

I'm ignoring taxes?

Which number is wrong?

I don't get it you are investing $6,250 before taxes in both. There's nothing not accounted for.

I think most are missing the $1,250 tax savings invested.

quote:

Originally posted by Skins2881:
I don't get it you are investing $6,250 before taxes in both. There's nothing not accounted for.

I think most are missing the $1,250 tax savings invested.

I'm struggling to help Fly-Sig to see it my "wrong" way.

He's stuck on that it takes more gross income to fund a $5K Roth than a $5K 401(k). That's not the comparison I’m making.

I’m holding the contribution size constant—$5,000 invested in each account—and comparing what that grows to under their respective tax rules. That's how Vanguard, Fidelity, and every other retirement calculator models it.

If I contribute X to a 401(k) or X to a Roth, which leaves me better off after taxes? It's not the same.

To keep it apples-to-apples, I also account for the tax savings from the 401(k) in a brokerage side account and apply taxes to those gains. The entire tax situation is captured. If I didn't do that, the Roth side would be even more at an advantage.

Much of the traditional thinking in whether or not to fund a tax-sheltered investment account revolves around an assumption that ones marginal tax bracket will be lower in retirement than it was while working. Ignoring this possibility in these sorts of calculations risks making the whole calculation meaningless. OTOH, this assumption may no longer be valid because tax rates are not fixed over time, and, if you save enough, your taxable income may actually increase in retirement. Not to mention that Govt. greed may affect the tax-sheltered status of different investments in unpredictable ways at an arbitrary point in the future (or even retroactively).

The calculation as to which is the wisest choice, IRA, 401K, or Roth is likely to be very individual, and not fixed over the remainder of one's working years. Employer contributions to a 401K usually make it the premier choice in almost all cases.

But, the raw return, and how much of it si confiscated by Govt. are far from the only considerations. For me, and I suspect many others, the greatest benefit of having significant savings is to have the flexibility of not having to make a forced (bad) decision when confronted by an unexpected financial crisis. What amount of money this might be is likely to be very individual as well. Arguably, having your savings in a Roth rather than a "pay a tax upon withdrawal" account results in a slightly more palatable outcome should a situation like this arise.

quote:

Originally posted by Keystoner:

I'm struggling to help Fly-Sig to see it my "wrong" way.

He's stuck on that it takes more gross income to fund a $5K Roth than a $5K 401(k). That's not the comparison I’m making.

I’m holding the contribution size constant—$5,000 invested in each account—and comparing what that grows to under their respective tax rules. That's how Vanguard, Fidelity, and every other retirement calculator models it.

If I contribute X to a 401(k) or X to a Roth, which leaves me better off after taxes? It's not the same.

To keep it apples-to-apples, I also account for the tax savings from the 401(k) in a brokerage side account and apply taxes to those gains. The entire tax situation is captured. If I didn't do that, the Roth side would be even more at an advantage.

You are NOT investing $5k in a ROTH if you deposit $5k into it. Let me try another example.

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. Compare that to buying something else with no sales tax up front, perhaps art, but later when selling it you have a 25% broker fee. If both the gold bar and art double in value, your final net is the same. You just paid expenses up front rather than at the end.

This is specifically why your original scenario is flawed. You are comparing different initial costs of acquiring an investment account. The 401k cost is the face value of $5k because there are no taxes. The ROTH costs more up front than the face value of $5k. Your ROTH is underwater $1250 on day one.

Brokerages may be spinning it differently, idk. I'm looking at if you have a total of $X to put into a retirement account of any sort. I've seen some financial advisors spin it similar to you, saying to find the tax $ elsewhere and roll over a larger amount, and how much more fabulous it is than keeping the 401k. It is disingenuous on their part to dismiss the taxes.

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.

No, I don't need $6,250 at the gold bar store. They just want their $5,000 and I'll spend the $1,250 at the IRS store.

Instead of side analogies, let’s focus on the numbers in my original spreadsheet (top of page 1).

Fly-Sig, I got you. This spreadsheet is just for you.

This is what you're trying to argue, and I'll show you why it's flawed.

You're trying to constrain the gross income for both sides to be the same and you're trying to do it with a gross income of only $5,000, and if the Roth side has to pay 25% tax on that ($1,250), then there will only be $3,750 available to fund a Roth. Then you do your comparison from there and show the net worth is the same in the end. Is that a fair comparison--seed the 401(k) with $5,000 and the Roth with $3,750?

That's not my scenario at all. In order to do my comparison, and have both sides have the same gross income, and at least $5,000 in each investment vehicle, that gross needs to be at least $6,667. 25% of that is $1,667, leaving $5,000 to fund the Roth.

I'm not ignoring taxes anywhere.

I have the spreadsheet. Tell me what scenario you want to see.

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.

No, I don't need $6,250 at the gold bar store. They just want their $5,000 and I'll spend the $1,250 at the IRS store.

Instead of side analogies, let’s focus on the numbers in my original spreadsheet (top of page 1).

Well of course if you put the exact same number of dollars into 2 accounts, and those accounts are invested exactly the same, the gross value at the end is exactly the same. In your example you took $5k and ended up with $226,296.

But you then claim that it is flawed when people claim that the only difference is the tax rates at the front end vs the back end. This is where you are wrong.

You already paid taxes upfront on that $1250 you put in the brokerage account for the 401k future taxes. It really cost you $1666.67 to fund that account.

quote:

Originally posted by Fly-Sig:

But you then claim that it is flawed when people claim that the only difference is the tax rates at the front end vs the back end. This is where you are wrong.

You already paid taxes upfront on that $1250 you put in the brokerage account for the 401k future taxes. It really cost you $1666.67 to fund that account.

~Sigh~

quote:

Originally posted by Fly-Sig:
Well of course if you put the exact same number of dollars into 2 accounts, and those accounts are invested exactly the same, the gross value at the end is exactly the same. In your example you took $5k and ended up with $226,296.

From what you just cited, do you see that the from that $226,296, the 401(k) person now has to pay $56,574 in taxes and the Roth person gets to keep all of it?

Pay now or pay later.
We did the 401k during our earning years, which was great because it reduced our tax burden at that time.
The problem is that today, I'm pulling about 12k a month out to cover living expenses and getting killed on the taxes. (My wife developed Alzheimer's and the cost of her care in an assisted living facility is steep.)
I loved having the tax deduction then, but I wish I that I had done at Roth now.
Pay now or pay later.

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. Compare that to buying something else with no sales tax up front, perhaps art, but later when selling it you have a 25% broker fee. If both the gold bar and art double in value, your final net is the same. You just paid expenses up front rather than at the end.

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

The art guy: -5,000 (buy art) + [Time] + $10,000 (sell doubled in value art) - $2,500 (broker fee) = $2,500

quote:

Originally posted by Keystoner:

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

The art guy: -5,000 (buy art) + [Time] + $10,000 (sell doubled in value art) - $2,500 (broker fee) = $2,500

Uh, yup. Maybe I wasn't clear? I was rushing.

The gold guy has $10k net at the end, but he put in more up front than art guy. Gold guy nominally put in $6250 but he probably paid tax on a larger amount first to get the sales tax money. Art guy only put in $5k.

Now if gold guy finds the 25% sales tax money somewhere else and doesn't count it, he has a $5k investment that doubles and he keeps it all. But that is a deceptive claim, which many financial sources make. They presume you find the taxes elsewhere, especially in doing a ROTH conversion, and then ignore the big picture.

I am a huge proponent of ROTH to the greatest extent possible, so I'm not knocking anyone who maximizes their ROTHs.

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).

Those equations are the same. If you start with the same total dollars then the only variable is the tax rate. This is why your claim is wrong about interest rates. They are in fact the only factor in whether a 401k or ROTH will be better.

If you have an external source to pay for the taxes in either case, you either must calculate it for both or for neither, but if you don't start with the same total cost to get in then your results are corrupted.

Good Lord! There's got to be a resolution to this. Someone has to be right. Lol.

There are none so blind as those who refuse to see.

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.

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.

Multiplication is commutative, so it dies not matter if taxes are taken first or last in the equation, only whether that tax rate is the 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.

Why don't you gross up the 401k to the same total as it costs to fund $5k into the ROTH? There is not a $5k limit to a 401k contribution.

Put $6250 into your 401k and run the math, taking out 25% at the end.

^^^ you don't need excel to do that. It works out exactly the same as long as tax rate is same in accumulation and draw down period.

Great thread, and timely. Thanks. With approx. 11 million folks turned 65 everyday, there is no end to the number of youtube videos on the subject of Roth conversion. I will probably consider taking small bites out of the 401k in-plan each year until in retire (~7 yrs) to not go past 22%. I'm also in the process of setting up a Roth metals IRA, and would roll-over (in-service) to buy more metal. I'm sure I'll talk to my provided advisor at some point after I've accumulated more knowledge on the whole subject.

I really do appreciate the contributions here to help motivate me to learn about this. It's obvious the Government is promoting conversion as it wants more money now. I just need to determine what tax bracket I expect to live in the future. I won't change much probably.

Now to re-read all the posts and try to understand what you all talkin' about

I’m fine with being late to this party.

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.

There are a handful of caveats, is there a company match? Supports the 401k. Does your company have really lame investments for the 401k? If so, takes away from the 401.

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

One could end up splitting hairs, when the big danger is doing nothing.