Warning: Math-Heavy Post! I only have 4K left to go on my 401K, but I changed it to Roth. I earn way over the cap for a Roth IRA, so a Roth 401(k) is the only Roth vehicle I have.
A Roth 401(k) is the same as a regular 401(k) if taxes stay the same. I'm serious, though I did this math a billion times. Even Jonathan's math agrees. This one is kind of hard to stomach, but here's the math. I am investing $10,000 now, assuming 10% growth and 33% taxes now and 40 years later. 33% is my current rate
Roth = $10,000 * (1-.33) = $6,700 initial investment
Regular = $10,000 initial (untaxed investment)
After 40 years:
Roth = $6,700 * (1.1^40) * no taxes = $303,000
Regular = $10,000 * (1.1^40) * (1-.33) = $303,00
That initial hit down to $6,700 feels like a big hit. But remember, a Roth is the same if taxes stay the same. By investing in a traditional 401(k), I am saying to myself and to the world that I think my taxes are going down, that is, they will be less than 33%. That's untrue, I hope.
I have decided that I believe my taxes will increase. First, even if taxes stay the exact same, I hope--nay, plan--to be in the 38% bracket by earning over $350K combined. I aspire to be, and will be in the highest bracket. In the example above, that 38% bump alone turns $303K into $280K. Ouch.
Second, I believe taxes will increase because of our fundamentally broken social security and health care systems. I believe those taxes will fall on the high-earners (me) to care for an entire generation with no nest egg. So, even if taxes stay mostly the same, I think they will be raised on people like me.
I now have a new goal to invest the maximum, $15,500 (over 23K pre-tax) in my Roth 401(k) next year.
4 comments:
Having a Roth makes it possible to have more money than other taxpayers AND enjoy a lower tax rate than the suckers who don't have as much money as you.
Is this a great country or what?
I would not call 33% a low tax bracket.
I would call it low only relative to what I think the future holds for MY tax rate because of my future success and future social policy.
Hey, I'm pondering the same thing and found your calculation helpful... if you don't mind, I'd like to link your post to the one I'm currently writing on the topic
Bad advice. It depends on income, where you live, where you plan on retiring, and what you plan on doing for the rest of your life. Why?
Because you have a 401k and decided to not work for 1-2 year. Roll that sucker into a regular Roth IRA that year and pay 15-20% taxes. Why pay more taxes than you have to?
Second, if you live in a high income state, I know you don't, but you are giving bad advice to people, like CA or NY, then move to Washington or Texas or New Hampshire or Florida, bammo, you just saved paying state income taxes. Which in CA is 12%. Ouchie. Can you make that sucker up??? No.
Third, read this and run the numbers again. Every scenario is different depending on your personal situation. http://www.fpajournal.org/CurrentIssue/TableofContents/ThinkingAboutaRoth401kThinkAgain/
Fourth and final do you wanna be Buffet or not? A roth is not necessarily the answer. You want to be able to live on dividends and long term capital gains.
Also funny thing, being a independent business owner makes things different. How different? Well things can be written off like your leased car. So reconsider and run more numbers! A bad year economy and business, time to roll the regular 401k!
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