Factors that tend to favor Roth IRA and Roth 401k tax-advantaged plan contributions
In a recent article, “Traditional versus Roth tax-advantaged plan contributions,” The Skilled Investor discussed why the average taxpayer would tend to benefit more by contributing to traditional rather than to tax-advantaged Roth IRA and Roth 401(k) retirement plans. This follow-up article in two-parts discusses eight personal financial planning factors, which could flip one’s preference toward making current contributions into Roth tax-advantaged plans instead.
Many people struggle with the “traditional versus Roth” contribution decision for their personal financial and investment planning. The tradeoffs over a lifetime are very complex.
Rules-of-thumb, back-of-the-envelope calculations, and simple spreadsheets cannot model all the important personal financial factors. The decision is not simply about present versus future tax rates. Instead, the decision requires a personalized and comprehensive projection and valuation of your lifetime income, expenses, debts, net assets, and taxes. Because The Skilled Investor has developed a comprehensive and automated financial lifecycle planner, we are in a relatively unique position to comment on this complex topic using the results of our model. We can rapidly model and project personal financial tradeoffs across anyone’s lifecycle, while taking into account personal taxes across one’s lifetime in eight federal, state, and local tax categories.
Often the “traditional versus Roth” decision conversation involves sometimes heated debates over current versus future marginal tax rates.
Many people have speculated recently that marginal U.S. personal ordinary income tax rates are likely to increase in the medium-term to long-term future. They reason that raising future tax brackets is one of the possible measures that would help to close the three huge funding gaps for the Social Security, Medicare, and federal employee retirement programs. While these predictions might become reality, once you start speculating about changing tax rules across a lifetime, an already complex lifecycle modeling problem becomes far more complex.
For purposes of this article, we will assume that the current tax rules will stay the same over one’s lifetime. There is just no way to tell when, how, and by how much marginal tax rates on ordinary income and/or capital gains taxes might change. In addition, if changes do occur, would they affect all accounts or only new accounts? When tax laws are changed, one way that politicians get interest groups off their backs is to “grandfather in” or continue some or all of the old rules for existing accounts. [...]