Factors that tend to favor Roth tax-advantaged plan contributions – Part 2
(Continued from Part 1…)
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 Roth tax-advantaged IRA and 401k 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.
6) In the early years, you may have proportionately higher front-loaded itemized deductions (e.g. mortgage interest and real estate taxes) and lower earned income that effectively lowers your federal, state, and local marginal ordinary income tax rates compared to your more distant retirement years.
7) You will adopt a very low-cost investment strategy to improve your chances of capturing higher asset appreciation rates. Therefore, you will not transfer a significant percentage of your asset returns annually to financial intermediaries who will promise to deliver more, but who are more likely to deliver less.
Elsewhere, The Skilled Investor has written extensively about excessive investment costs, but the bottom line is that every year the average individual investor probably wastes about 2% of his total assets in visible and hidden investment costs (management fees, marketing fees, loads, trading costs, custody fees, etc.). The cost efficiency of your investment strategy could make or break your “traditional versus Roth” contribution decision.
For example, a typical 30-year old professional couple might end up with $1 million in financial assets (cash, bonds, and stock) at age 100 with a low cost investment strategy. Holding everything else in our model constant, when we instead plug in the average costs of the average investor, this couple’s financial assets would be exhausted around age 90. If they are lucky enough to live to age 100, then they would have to liquidate their home or other assets to make ends meet after age 90. In the first circumstance, they are happily paying for their grandchildren’s education and traveling. In the later situation, they have to sell their home and watch every penny.
Clearly, the cost efficiency of your investment portfolio can completely flip your “traditional versus Roth” tax-advantaged account contribution decision. If, year after year, your investment costs drag down your asset growth significantly, then you could use up the smaller balances in your traditional or Roth accounts to eat and [...]