Examine a Roth 401k tax strategy

Whether or not to invest into a traditional tax-advantaged employer plan and IRA accounts versus contributing to “Roth” IRA and tax-advantaged employer plan accounts is not always a straightforward decision.

The decision on the trade offs is one of the most complex decisions of do-it-yourself financial planning. A broad array of financial factors can influence whether a regular IRA or tax-advantaged employer plan account contribution versus a Roth IRA or tax-advantaged employer plan retirement account contribution decision would be best.

If analyzed properly, the majority of people would find that making further investments into a traditional tax-advantaged employer plan or IRA accounts is the best choice, when those deposits would be currently tax deductible.

The trade-offs are complex. Back-of-the-envelope calculations are not able to model all the critical tradeoffs. The choice is not simply about present versus future tax rates. Instead, the decision requires a fully personalized financial planning projection and analysis of an investor’s lifetime income, taxes, and assets.

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Whether or not a family will save enough to invest carefully across their lives is most important in the Roth retirement account versus the “currently tax deductible” ordinary retirement plan contribution decision.

If an investor cannot make enough money, does not save aggressively, does not strictly control investment costs, and/or does not build up a sufficiently substantial portfolio of assets, then that investor won’t be in the upper tax brackets when retired — regardless of whether federal and state income tax brackets have changed by retirement. If an investor will not have substantial enough assets and income in old age, then the present tax advantage an investor can get from deciding on a traditional retirement account contribution would work out to be much more financially favorable over a lifetime.

Note: This discussion ONLY focuses on personal financial circumstances where the person has the choice of making a “deductible against current income taxes” ordinary IRA or 401k contribution versus a currently “not deductible against current income taxes” Roth IRA or 401k additional investment. If you cannot get the deduction this year but have available a Roth deposit, then the Roth contribution is more desirable.

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