Roth vs Traditional 401k – Tax Free Millionaire in Retirement

Roth vs Traditional 401k: Which is better?

In today’s video, we talk about the impact of saving pre-tax (traditional) vs after-tax (Roth) in your 401(k).

We walk through a retirement case study that calculates an additional $221,678 in tax-free income in retirement using a Roth vs Traditional 401k.

Show Notes:

Full transcript:


Anthony Saffer & Alex Okugawa

Full Transcript:

Alex Okugawa 0:00
Should you go with pre-tax or Roth contributions into your 401k? Stay tuned to find out how to maximize your retirement savings.

Hi, there, it’s Alex and Anthony from One Degree Advisors. If you enjoyed today’s video, please like and subscribe for more. So today we are discussing pre-tax or Roth 401 K contributions, which is better.

Anthony Saffer 0:26
Yeah, so let’s start with the difference pre-tax contributions, you’re getting a deduction for those contributions. And then paying tax on the backside, when you take withdrawals from your retirement account, Roth This is a flip flop, you don’t get the tax deduction upfront. But in addition to that principle, which you’ve already paid tax on, plus all the earnings that you can get all the growth that you can get, you can withdraw that tax-free in retirement.

Alex Okugawa 0:47
This is a really big decision, right? I mean, depending on when you do this, and the decision you make this has the potential to save you 1000s hundreds of 1000s of dollars in tax over your lifetime by just making a couple of these tweaks. Now, age and tax brackets are the two biggest factors in this decision.

Anthony Saffer 1:04
So generally speaking, someone that’s younger, is going to be better off with the Roth contribution simply because they have more years to allow for that compound growth. They have time on their side. Yep, time on their side, someone older, often leaning towards the tax deduction.

Alex Okugawa 1:18
The other side is the tax brackets. So where will you get your tax benefit? Are either doing it now?

Anthony Saffer 1:25
Or do you want to later, and it’s often coordinated with age, right, someone that’s younger, they’re earlier in their career, oftentimes, they’re not always, but they’re in a lower tax bracket. So they don’t need that upfront tax deduction quite as much.

Alex Okugawa 1:36
So the Roth makes a lot of sense for younger people, one because they have time on their side, too, because they’re typically in a lower tax bracket. So pay some tax at today’s rate to get tax-free income later, older folks, right, you don’t have as much time for that to grow compound tax-free. So get the tax deduction now, because you’re likely in a higher tax bracket. But of course, everyone’s situation is different.

Anthony Saffer 1:55
And the other thing too is that when you know what your tax bracket is when you get into retirement, that’s sort of a guess and a presumption as to what that tax bracket is going to be when you go to withdrawal.

Alex Okugawa 2:06
So let’s take a look at just historical tax brackets history. So we’ll pull this up on the screen right now. This is the history of tax rates, going from 1913 to 2021. Now, again, this is the top federal tax bracket. This isn’t like a blend of an average, this is the top. But the main message here is to look at this. I mean, we’re really at historically low tax brackets. So this again presents an opportunity where the decisions people are making now can have a big impact down the road.

Anthony Saffer 2:40
So what some people will take from this is that tax rates are more likely to go up in the future, because of high national debt or low historically, tax rates, therefore, I want to get the tax break later when they go up. So let’s take a look at some examples here. We’re going to this is a calculator through bank rate, we’ll put we’ll post the link in the notes here. So this is a 30-year-old. And we have them saving $10,000 a year until they get to age 65. Some presumptions here, and that’s kind of the best we can do is try to estimate those out, we’re expecting that they’re going to earn 8% per year, because they’re younger, earlier in their career, maybe their tax bracket right now is only 12%. But they’re estimating that they’ll move into more of a traditional average type of tax rate when they get into retirement and 22. Therefore, it’s going to be higher when they get into retirement. And because of that, they don’t need that tax deduction quite as much right now. And in this case, the Roth would be better off for them to be adding that money.

Alex Okugawa 3:43
And you’re looking at a difference of about $200,000. Right, right there. It’s big.

Anthony Saffer 3:48
Now let’s flip it over. And now we go, we have a 50-year-old, who’s saving for the next 15 years. And in this case, the amount doesn’t matter quite so much. But they’re saving $20,000 per year, the same expected rate of return of 8%. At this point in their career, they’re in a high tax bracket with high earnings. And then their expectation is they’ll drop back to more of an average type tax bracket at 22%. When they get into retirement. And in this case, you’ll see that the pre-tax generally works out better. And this does estimate the way we have this set is that they’re taking those deductions savings that they’re getting, and they’re re-adding it into other investments. In other words, they have more to invest.

Alex Okugawa 4:28
Yeah, there always has to be several assumptions. Whenever you look at these projections. I mean, you’re assuming, you know, tax rates in the future, which who knows Good luck trying to estimate tax rates in the future. But the takeaway I’ve had from this as well, especially with younger folks that might be high-income earners that are younger, is that it doesn’t have to be an all-or-nothing situation, right? With most 401k plans. You can split these contributions, you can do some into a pre-tax account, get that tax deduction, and then you can do maybe the other half APH in a Roth 401 K. And this is great because it gives you tax diversification, which is so powerful when you retire to be able to kind of pick and choose and play the tax bracket game in retirement when you’re taking income to figure out okay, how do I navigate this? Okay, let me take a little bit from this account because it’s tax-free. And we take some of this account because I’m in a super low tax bracket, really, really helpful for folks when they have that diversity.

Anthony Saffer 5:23
So although we’ve shown the use of a calculator, it has to be taken with a grain of salt that it can’t factor in everything having that tax flexibility that you mentioned. Therefore, when you get into retirement, you can use that tax planning to your advantage is a great benefit.

Alex Okugawa 5:37
And now let us know what you think. Do you prefer to make pre-tax contributions into your 401k or Roth and why? Let us know in the comments below. And if you have ideas for future videos, let us know if you enjoyed today’s video please like and subscribe for more. Thanks for watching.

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