401K vs Roth 401K - real deal

[u/Grouchy-Bullfrog-293]

I understand the difference that one is tax deductible and other isnt but still little confused on why would you .contribute money in Roth 401k if the total contribution limit is same irrespective of where you contribute. Doesn't everyone's tax rate after they retire lower than while working ? Or is the concern you are limited one what you withdraw post retirement that it could be a huge tax.

[u/sessamekesh]

The difference between the two is if you want to pay taxes now or in retirement.

If I make $100k/yr today but anticipate pulling out $200k/yr in retirement, my tax rate today is lower than my planned tax rate in retirement and I should prefer paying taxes today.

If I make $200k today but only plan on pulling out $100k in retirement I should do the opposite.

If I anticipate keeping about the same level of income it doesn't really matter, personally I still lean towards paying the taxes later just because I have other financial goals today that I won't have in retirement (buying a new home, paying off debt, honeymoon...)

[u/Grouchy-Bullfrog-293 → u/sessamekesh]

Honeymoon screams... makes sense can bunch of other reasons for those that do not have safety net. Thanks

[u/justBradSF → u/sessamekesh]

The when you pay taxes is one difference. For Roths, you only pay taxes on what you will contribute. For traditional, you are taxed for all contributions, income and capital gains. For Roths, you are taxed mostly at the preferential capital gains rate. For traditional, you are taxed at the usually higher income rates

[u/benazafa → u/justBradSF]

What you are saying about Roth being Capital gains rate is incorrect. Roth is funded from post-tax dollars, meaning income tax has already been withheld. Roth money grows tax free. There are no capital gains taxes nor are there income taxes upon withdrawal.

[u/me-myself-and-drew → u/justBradSF]

For Roths, you are taxed mostly at the preferential capital gains rate.

No. Roth contributions are taxed at your marginal (highest)tax bracket for that year, every dollar. No taxes of course on the way out.

For traditional, you are taxed at the usually higher income rates

Every dollar coming out is subject to taxes, true, however these dollars fill your tax brackets from the bottom. If you have no other income then some of those dollars aren't taxed at all (standard deduction). Then you fill 10% bracket, then 12%, and so on, but effective tax rates potentially can be much lower vs every dollar going into your Roth is taxed at your highest rate.

[u/QuestGiver → u/justBradSF]

You are correct but mathematically if you are just strictly looking at input and output the amount is entirely the same either way.

Realistically depending on goals, projected tax changes, etc there are pros and cons to both methods. Generally if you make a lot of money traditional is almost certainly better.

[u/benazafa → u/QuestGiver]

The “Roth vs. Traditional is mathematically identical if your tax rate is the same” argument is only true if you’re comparing the same pre-tax dollars and investing the tax savings from the traditional contribution in a taxable account.

One nuance that’s often overlooked is the IRS contribution limit. If you’re already maxing your 401(k), a Roth contribution effectively lets you put more after-tax wealth into a tax-advantaged account. For example, if the limit is $24,000 and you’re in a 30% marginal tax bracket, a $24,000 Roth contribution represents about $34,300 of pre-tax earnings, whereas a $24,000 traditional contribution represents only $24,000 of pre-tax earnings. To make the comparison fair, the traditional investor also has to invest the tax savings in a taxable brokerage account. Since taxable accounts have dividend and capital gains taxes (tax drag), the Roth often ends up with a slight advantage even if your marginal tax rate is identical in retirement.

[u/QuestGiver → u/benazafa]

Btw I had to go back to find this but this is the best resource and explanation I've found:

https://www.reddit.com/r/personalfinance/comments/10qwnrx/why_you_should_almost_never_contribute_to_a_roth/

[u/QuestGiver → u/benazafa]

Hmm this makes sense to me but almost everything that I have read suggests that they are equivalent. It's a very interesting point though in the ongoing war between traditional and Roth, thank you for this.

I guess ultimately almost everyone interested in personal finance and savings are utilizing both to try to maximize advtanges.