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Author: MurrayS Big red star, 1000 posts 10+ Year Anniversary! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75536  
Subject: Re: Roth 401k vs. Traditional 401k Date: 10/1/2012 11:05 PM
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Here's something I learned when looking into converting traditional IRAs to Roths several years ago:

When you divert money or convert from a traditional 401k or IRA, the income is tacked on top of your existing income and taxed at your highest marginal rate. In my case, that's above 30%.

When I retire, of course my traditional 401k & IRA withdrawals will be tacked on top of my income, but guess what? I won't have any income besides 401k or IRA withdrawals!

This means that we will pay ZERO tax on the first $19,500 of withdrawals each year due to the current standard exemptions and deductions.

The next $17,400 will be taxed at 10%. The next $53,300 will be taxed at 15%.

Putting it another way, my wife and I could withdraw $90,200 (we should be able to live on that ;) and pay under $10k in taxes for an effective tax rate of under 11%.

You might notice I didn't take into account SS. Let's say we make $30k in SS income and we withdraw another $60k to get to $90k. For the sake of argument, let's assume all the taxes are paid after the SS income. In other words, we pay $10k of taxes on $60k of IRA withdrawals. That would STILL be under a 17% effective tax rate which is way under 30%.

Bottom line, it made little to no sense for us to convert a traditional IRA to a Roth. Of course, if you're in a lower marginal tax bracket (15% or below) or you will have a substantial income in retirement, a Roth will make more sense. It's also a great idea to have a Roth to have more tax flexibility and avoid RMDs.

But, people seem to forget our tiered tax system and the difference between marginal and effective tax rates when considering traditional and Roth IRAs.

-murray
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