The Roth IRA Tax Trap: Why The 22% Growth Rule Is Wrong 😬

[@Jazzwealth]

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[@DavidAlan2Win]

Glad to see #66 Dustin! I’ve definitely taken some tax hits over the years going out of my way to get my holdings into Roth status. The peace of mind and sweetness of watching my nest egg grow tax-free has been worth every dollar of taxes paid.🤑

[@keithmachado-pp6fv]

Actually you need to compare marginal tax rate to marginal tax rate not marginal to effective. In both cases the income goes on top of all your other income not a blended rate. You can certainly make an argument that your marginal rate will be lower in retirement, for example if all you have is SS then taking into account the standard deduction you could pay zero tax on a portion of your RMD. But it still goes on top of your other income just like the Roth contribution or conversion would.

[@IvyTibbitts]

Thanks. Always great info

[@adi4FI]

If you contribute money to a Roth IRA in your marginal tax bracket, why is the money coming out from an IRA not in your marginal tax bracket? Why for the withdrawal we should look at effective tax rate? If we need all the money coming out the IRA to live on, it could push us into a higher marginal bracket. What am I missing?

[@peardisplay]

smoke and mirrors.

[@keithmachado-pp6fv]

You are correct it is marginal compared to marginal.

[@traviswilliamson8688]

It is my understanding that withdraws from a Roth don't count as income if all the rules are met and will not move you into different brackets once withdraw is made.

[@keithmachado-pp6fv]

The withdrawals referred to are coming from a traditional IRA not a Roth.

[@kersting13]

It goes in AND comes out at your "effective" rate. When you put it in, it comes "off the top", and when you draw it, it adds on the top. It's a lot more likely that your contribution is 100% at your marginal rate, vs at withdrawal, it's a lot more likely that your withdrawals will be rolling up through brackets. All I'm saying is that it's a lot more likely that at contribution, your marginal and effective rate on the contribution are equal, while at withdrawal, it's a lot more likely that your effective and marginal rates are NOT equal.

[@brucesmith6868]

Thanks Dustin

[@davidmason1043]

Interesting topic. I think taxation of social security and (for higher income tetirees) IRMAA should also be taken into consideration - pre-tax distributions in retirement can pull more SS to become taxed, increasing effective tate. And of course its not exactly voluntary once RMD's kick in. Might be a moot point in 10-15 years as essentially everyone with taxable "other income" will have 85% of their SS counted as taxable income because the base numbers have never been inflation adjusted, but still something to consider. Roth doesnt always win, but it sure as hell is simpler. Another approach would be just to be tax diversified, so one would at least have opportunities for planning.

[@bruceanderson8179]

Not all retirees have lower effective income tax rates. With the exception of our first three years of retirement when we kept our income low and took advantage of ACA provisions our effective tax rate remains just about the same as that in our working career. During our careers we contributed to tax deferred 401k plans up to the match (we didn't have Roth options) and when Roth IRAs became available we made full contributions to those. We're now a little over a year from taking RMDs. Those RMDs, thanks to the contributions we made during the course of our careers, will push us into the next marginal bracket and the highest effective tax rate we've ever encountered. We have made conversions up to the point of bracket creep but will still cross into the next bracket with RMDs but not as deeply given our conversions. The point is, not everyone fits a broad based presumptive mold and more probably do not fit than expected.

[@wrb5813]

As always great topic to discuss. A blended approach would include contributing to the IRA and contribute the tax savings to the Roth. Would this approach be more beneficial than an all to one account or the other?

[@uconn1975]

First off, love your content. you guys rock. I struggle with the whole current marginal vs future effective tax rate argument sometimes. If i’m deciding whether to put my next incremental dollar into pretax vs roth, why would I not consider the marginal rate that the incremental earnings on that dollar would be taxed? 100% agree on all the other benefits of Roth, and to be fair i’m still contributing primarily to Roth even though i’m approaching peak earnings for all those reasons. Otherwise said, If I earn an extra dollar in retirement due to me contributing an extra dollar now, isn’t that extra dollar taxed at my then-to-be marginal rate? Shouldn’t that factor as an input?

[@silver6054]

A score is 20 (as in man lives 3 score years and 10), but still!

[@thorstenvogt6561]

Not convinced that I should be using the >effective< tax rate for withdrawals for this comparison. In retirement, each additional withdrawn dollar will be taxed at my >marginal< rate too, if it is not a Roth dollar. Plus, non-Roth dollars can even increase taxation of Sec income on top of that. Personally, I am aiming for a Roth/non-Roth mix, for maximum tax flexibility in retirement.

[@338mag]

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[@KeeptheChange41]

Am I missing something, where is the closing beat?

[@keithmachado-pp6fv]

You make a good point which is while you are working and have more income you may benefit from the tax deduction in a higher tax bracket if your projection is you will be in a lower tax bracket later when RMDs are due. However where you go astray is comparing marginal tax brackets to effective. No disrespect but it’s not correct. You need to compare marginal to marginal. Here is a perfect example. You are retired and 60 years old and have $100k of investment income and convert $50k to Roth. You pay the tax on the $50k at your top tax bracket. Fast forward to age 75 when RMDs kick in and you still have $100k of investment income (and also SS but that is not the point). Your RMD is similarly taxed at your top tax bracket so apples to apples is marginal to marginal not marginal to effective.

[@jn8559]

I expect taxes will go up in the future due to the large national debt. For this reason, I am investing in Roth. If I am wrong, my inheritors will appreciate my thoughtfulness.

[@Bill-vk7fh]

There are some scenarios where Roth conversions make a lot of sense. But in many cases, Roth conversions are very difficult to quantify as so many assumptions are used. Change one assumption and your previous analysis is incorrect. I take the middle ground so I'll be at least 50% correct :-).

[@CalmerThanYouAre1]

This logic doesn’t follow. It always makes more sense to take the tax deduction today at the 32% rate in order to pay potentially 0% or a much lower blended rate when you withdraw the funds and retirement. The Roth is only the best idea for Low income earners, typically. Especially after you include the benefits of investing, the upfront tax savings from today’s traditional deduction in a Roth account.

[@MarkB-s9m]

A “score” is 20, not 10.

[@LRivera2760]

Can’t wait

[@truthsleuth271]

I might need fact checked on this but I believe that money you put into a 401k or IRA reduces your reported income each year that is used to calculate your social security. That’s what it appears to be from my income statements, anyway. If so, that should be factored into the calculation for whether a Roth or IRA is better for you.

[@Bill-vk7fh]

From IRS dot gov: "The amounts deferred under your 401(k) plan are reported on your Form W-2, Wage and Tax Statement. Although elective deferrals are not treated as current income for federal income tax purposes, they are included as wages subject to Social Security (FICA), Medicare, and federal unemployment taxes (FUTA)."

[@Bill-vk7fh]

Per irs dot gov: "The amounts deferred under your 401(k) plan are reported on your Form W-2, Wage and Tax Statement. Although elective deferrals are not treated as current income for federal income tax purposes, they are included as wages subject to Social Security (FICA), Medicare, and federal unemployment taxes (FUTA)."

[@338mag]

Oh, never thought of that one. I will have to check into that

[@Bill-vk7fh]

@@truthsleuth271 Money put into a tax-deferred 401k is subject to FICA taxes, but does reduce taxable income since it's deferred.

[@mcgravy60]

Any pre-tax deferments of income do not affect Social Security taxes and/or benefits. You can check your SS earnings history on the SSA website.

[@paulthoded]

This guy is off based on what he is stating

[@voodoodrug]

Also there good if your retired already and your wife works.