The marginal vs effective rate distinction is the single most misunderstood concept in retirement planning. Most people assume tax rates will go up, but even if they stay the same, the math heavily favors Traditional for high earners today. The calculator in your article should be required reading.
YES! Couldn’t agree more. I get why it’s misunderstood given that they are fairly technical and not easy to compare in your head, but they are so important if you want to make your money go farther.
Appreciate the comment and glad you liked the calculator
Totally fair. And having a mix of your portfolio spread across all of the differetn tax-treatments buckets in retirement is a huge advantage to be able to manage tax rates, strategically do conversions, get ACA subsidies, etc.
What are your thoughts on Roth vs Traditional for those of us with defined benefit pensions? I expect to have a pension of about 50-55k, which fills up a lot of that lower tax rate bucket right away. Then as a married-filing-jointly taxpayer, the marginal tax rate is basically flat from 100k to 400k, which is where my wife and I are earning now. At first blush it doesn’t seem like Roth vs Trad makes much difference.
Yes, David, your’re thinking about the right things. In your case, you should be comparing the marginal tax rate now versus the marginal tax rate in retirement.
In your case, I would think making sure you have a mix of both Traditional and Roth balances when you retire. Having both gives you the option in some years to pick from one or the other to manage tax rates, ACA benefits, and other things. If right now you have a big balance of Roth already saved, but no Traditional, then I would probably prioritize Traditional so that you have both options you can use to manage your taxes and retirement.
If you already have a some Traditional saved up, then Roth gets the edge given you expect your marginal tax rate to be similar in retirement as it is now.
Thank you! And you bring up a great point. RMDs are soooo important to plan for as you get closer to retirement. It can change the math, particularly if you retire very close to RMD age of 75. But if you retire at 65 or even earlier, you have 10+ years to do Roth Conversions and other strategies to ensure RMDs are not a major issue.
RMDs are an important reason why having ‘tax diversification’ of your portfolio is a great strategy. That is, having some of your money in tax-free Roth, some in tax-deferred Traditional, and some in taxable accounts. In retirement this lets you pick and choose which to withdraw from in any given year so you can deal with RMDs and manage to lower marginal tax rates.
The default tax strategy I recommend for most people in their high-earning years is to invest in a combination of a Roth IRA, a Traditional 401(k), and some taxable investments.
Correct me if I’m wrong…when I withdraw from Roth IRA after 60 I don’t have that money taxed as income. When you withdraw after retirement from a 401k you do get taxed as income from the state.
Yes, that's true that , when you withdraw from a Roth after 59 1/2, you don't pay taxes on it.
In a 401K, it can be either a "Traditional" account, which, like you said, you pay taxes when you withdraw in retirement, or you could have a Roth 401K, which behaves the same way as a Roth IRA.
The choice between traditional or Roth, either an IRA or a 401k (each has both options) becomes, when will you pay more tax? And that's a very important question financially. Most often, people pay more when they originally contributed to the Roth as opposed to when they withdrew in retirement from a traditional 401K because their effective tax rate is lower than their marginal tax rate while working.
The marginal vs effective rate distinction is the single most misunderstood concept in retirement planning. Most people assume tax rates will go up, but even if they stay the same, the math heavily favors Traditional for high earners today. The calculator in your article should be required reading.
YES! Couldn’t agree more. I get why it’s misunderstood given that they are fairly technical and not easy to compare in your head, but they are so important if you want to make your money go farther.
Appreciate the comment and glad you liked the calculator
Both serve their purposes and both should be utilized at different points along the wealth creation process.
Totally fair. And having a mix of your portfolio spread across all of the differetn tax-treatments buckets in retirement is a huge advantage to be able to manage tax rates, strategically do conversions, get ACA subsidies, etc.
What are your thoughts on Roth vs Traditional for those of us with defined benefit pensions? I expect to have a pension of about 50-55k, which fills up a lot of that lower tax rate bucket right away. Then as a married-filing-jointly taxpayer, the marginal tax rate is basically flat from 100k to 400k, which is where my wife and I are earning now. At first blush it doesn’t seem like Roth vs Trad makes much difference.
Yes, David, your’re thinking about the right things. In your case, you should be comparing the marginal tax rate now versus the marginal tax rate in retirement.
In your case, I would think making sure you have a mix of both Traditional and Roth balances when you retire. Having both gives you the option in some years to pick from one or the other to manage tax rates, ACA benefits, and other things. If right now you have a big balance of Roth already saved, but no Traditional, then I would probably prioritize Traditional so that you have both options you can use to manage your taxes and retirement.
If you already have a some Traditional saved up, then Roth gets the edge given you expect your marginal tax rate to be similar in retirement as it is now.
Thanks! This is great. However, doesn’t the math potentially change as you approach your RMDs.
Thank you! And you bring up a great point. RMDs are soooo important to plan for as you get closer to retirement. It can change the math, particularly if you retire very close to RMD age of 75. But if you retire at 65 or even earlier, you have 10+ years to do Roth Conversions and other strategies to ensure RMDs are not a major issue.
RMDs are an important reason why having ‘tax diversification’ of your portfolio is a great strategy. That is, having some of your money in tax-free Roth, some in tax-deferred Traditional, and some in taxable accounts. In retirement this lets you pick and choose which to withdraw from in any given year so you can deal with RMDs and manage to lower marginal tax rates.
The default tax strategy I recommend for most people in their high-earning years is to invest in a combination of a Roth IRA, a Traditional 401(k), and some taxable investments.
Thank you!
Correct me if I’m wrong…when I withdraw from Roth IRA after 60 I don’t have that money taxed as income. When you withdraw after retirement from a 401k you do get taxed as income from the state.
Yes, that's true that , when you withdraw from a Roth after 59 1/2, you don't pay taxes on it.
In a 401K, it can be either a "Traditional" account, which, like you said, you pay taxes when you withdraw in retirement, or you could have a Roth 401K, which behaves the same way as a Roth IRA.
The choice between traditional or Roth, either an IRA or a 401k (each has both options) becomes, when will you pay more tax? And that's a very important question financially. Most often, people pay more when they originally contributed to the Roth as opposed to when they withdrew in retirement from a traditional 401K because their effective tax rate is lower than their marginal tax rate while working.
Thanks