Roth or Traditional?🤔

Roth 401k/IRA or Traditional 401k? Here's how you can decide it for you...

In this newsletter, I want to help you think about whether you should contribute to a Traditional (pre-tax) or Roth account.

There is a big difference in the tax treatment between the 2 accounts, and it’s important to get it right:

• Traditional accounts give a tax deduction today in exchange for taxable withdrawals later

• Roth accounts give no deduction today in exchange for tax-free qualified withdrawals later

Let’s take a very simple example:

Say you are in a 22% marginal tax rate today and you put $10k in a Traditional 401k. Say that after x years, it doubled to $20k, which is $15.6k after paying that same 22% tax rate at withdrawal.

Using the same example, say you contribute $7.8k to a Roth account (after 22% tax, since Roth is an after-tax account), and it also doubles to $15.6k tax free, since you already paid the tax.

As you can see, using identical contribution and withdrawal tax rates, Traditional and Roth produce the same after-tax result

So your goal is to figure out:

1. What is my current marginal tax rate?
2. What is my future marginal tax rate when I start withdrawing from my retirement accounts?

That’s generally the most important part of this whole comparison. And unfortunately, it’s not super straightforward.

Estimating your current tax rate

The most accurate method is to run projections using tax software (or have a CPA run it for you)

You would:

1. Enter your income, deductions, and credits.

2. Add proposed Traditional 401(k) contributions.

3. Measure how much your taxes decrease.

For example, if contributing an additional $1,000 to a Traditional 401(k) reduces your taxes by $220, your marginal tax rate is 22%.

For simpler situations, such as someone with primarily W-2 income, there is an easier shortcut.

Take your income, subtract the standard deduction, and locate the corresponding tax bracket.

Example:

• W-2 income: $100,000

• Standard deduction (single filer for 2026): $16,100

• Taxable income: $83,900

That taxable income falls within the 22% marginal tax bracket. It gets tricky with phaseouts, credits, etc., but it should generally get you to a decent starting point.

So, every additional $ contributed to a Traditional 401(k) would save ~22 cents in federal taxes.

If your expected future marginal tax rate is lower than 22%, Traditional contributions would generally be better than Roth contributions.

But how do we then figure out the future tax rate? This is the hard part, because you need to figure out:

1. Your future income
2. What the tax law would look like x years down the road to calculate your marginal tax rate

For #2, let’s assume there are no tax changes. It’s a tough assumption, but it’s probably the best we can use to estimate.

For estimating your future income, it will likely come from a few different sources:

1. Pre-tax retirement accounts

Calculate future account value and multiply it by a withdrawal rate (e.g. 4%)

2. Taxable brokerage account

Estimate expected dividends from your taxable brokerage account, plus any capital gains (which mostly will be taxed at a preferential tax rate)

3. Social Security

Estimate your expected Social Security income using the SSA Quick Calculator.

4. Other income

Pensions
Rental
Business income
Any part-time work

Some of these may be hard to correctly predict, but perhaps something like a pension may be easier.

After projecting retirement income, subtract the standard deduction (note that there is an additional senior deduction that may apply) and figure out which marginal tax rate you would fall in.

For example, assume a single individual:

• Earns $225,000 from a W-2 job

• Has a current marginal tax rate of 32%

• Has $250,000 in a Traditional 401(k)

• Expects investments to grow at 8%

• Plans to retire in 25 years at age 65

• Expects inflation to average 2.5%

• Expects $3,000 per month from Social Security

• Does not anticipate additional retirement income

After projecting retirement income, he would likely fall into the 22-24% marginal tax bracket during retirement.

Even if future tax brackets increased by 5%, the projected retirement tax rate would still likely be ~27-29%.

Because his current marginal tax rate (32%) is higher than his projected retirement marginal tax rate, Traditional 401(k) contributions would likely be more beneficial than Roth contributions.

Of course, there may be other considerations like state taxes (e.g. what is your current state tax rate vs what is the tax rate of the state you plan to retire in), or Roth conversions planning.

Summary

To accurately estimate, you have to do some math, and assumptions. There is a common rule of thumb though:

• If you are in the 12% tax bracket or below, Roth contributions are often preferred.

• If you are in the 22% bracket or higher, Traditional contributions are often preferred.

I generally agree with this framework, but individual circumstances matter.

The best approach is usually to run projections based on your own expected income, retirement timeline, and future tax assumptions.

I hope you learned something new.

MC, CPA