Case Report: Roth or Traditional Contributions for a Low Six-Figure Household

Most of my writing is directed at physician households, and most (attending) full-time physician households have solid six-figure salaries. In a well-compensated specialty or with a dual income, it’s not unusual for a household to have income of $500,000 or more.

However, not all of my readers are in that position. Some are students or residents. A resident couple will make $100,000 to $120,000. A PA or NP may have a similar salary, as will many different combinations of individual or dual income households.

Today’s post was inspired by a reader who has a low six-figure household income. Six figures, yes, but nowhere near the $300,000 salaries of the doctors in our 4 Physicians series. He is married with children, and has heard conflicting opinions on how best to invest in his retirement accounts. Let’s help him with some answers.

To Roth or Not to Roth. That Is the Question.

 

This question comes up a lot, and frankly, I don’t spend too much time thinking about it, because for me or someone in a similar position, the answer is obvious.

Living and working in the upper tax brackets, it makes good sense for me to defer as much tax as possible by investing in a traditional, tax-deferred manner. I deduct and save more than 40% in taxes on every invested dollar, and I plan to withdraw or convert those dollars to Roth in a lower tax bracket in early retirement. The only Roth investments I make are “backdoor Roth IRA contributions” in lieu of $11,000 in what would otherwise be investments to our taxable account.

If I can take a deduction in the 33%, 35%, or 39.6% federal tax bracket (and a high state income tax), and later withdraw or convert in the 15%, 25%, or even 28% bracket, the math favors traditional, tax-deferred investments. I defer every penny possible.

However, a family with a low six-figure income may be facing a different situation. In fact, after exemptions and deductions, this family may be able to drop out of the 25% federal tax bracket and into the 15% tax bracket. Here are the brackets for 2017.

 

2017 Income Tax Rates

Roth or Traditional Contributions in the 15% or 25% Tax Bracket

 

As Michael Kitces (and dozens of others) have accurately pointed out, the most important determinant in making this decision is comparing your current and future (in retirement) marginal tax brackets.

  • Future less than current marginal tax bracket favors Traditional.
  • Future greater than current marginal tax bracket favors Roth.
  • Equal is a tossup. Or is it? More on that later.

 

To determine which will be the case for you requires some combination of knowledge and guesswork.

We can (and should) know our current marginal tax bracket. We can make an educated guess as to whether it will be the same or higher in retirement. For a potential early retiree, there is an excellent chance it will be lower in retirement. Why? Simply because there are fewer years to build up the balances and more years in which to spread out conversions and withdrawals between retirement and required minimum distributions at age 70 1/2.

The least predictable factor is what tax brackets will look like at retirement age. The further away that is, the more time there is for drastic change. Will we have a graduated taxation scheme, eliminating brackets altogether? Or a flat tax? Higher taxation across the brackets that resemble what we have today? Or lower?

While we don’t know the future, we can make a best guess. In the case of today’s subject, let’s say he currently has a gross income of $120,000. Let’s give him a wife and two kids. (actually, he’s already found / made his own). Currently 30 years old, living on about half his take-home pay to make FIRE a realistic possibility with current spending in the $40,000 a year range, he expects to work at least another decade or two.

Will His Future Tax Bracket Be Higher Or Lower?

 

Today’s subject has access to a SIMPLE IRA, HSA, and 2 Individual IRAs. Rounded off assumptions are $3,000 in mortgage interest, $2,000 in property taxes, $9,000 in FICA, and $5,000 in state income taxes. Like me, he lives in a high tax state.

Plugging these assumptions into Taxcaster, deducting a rounded up $7,000 for HSA contributions, $12,600 standard deduction, and $16,200 in exemptions, we arrive at a taxable income of $84,200, and a marginal tax rate of 25% for a total federal income tax of $10,700. Making maximum Roth contributions to his available retirements will not alter the tax picture.

If he makes traditional rather than Roth contributions of $12,500 (the max for SIMPLE IRA) and $11,000 into an individual and spousal IRA, he reduces his taxable income by $23,500, with about 1/3 of his tax deferral coming in the 25% tax bracket, and the rest from the 15% tax bracket. The transition occurs once taxable income drops below $75,900.

In this case, subtracting $23,500 (and the $7,000 for HSA) we arrive at a taxable income of $60,700, federal income tax of $6,200, and state income tax of $3,500.

Alright, that’s just way too many numbers in paragraph form. This post is in desperate need of a spreadsheet. Let’s do that.

 

 

Assuming our subject has a net worth of zero at age 30, having assets equal to his student loan balance, he can expect to have the equivalent of $1 million dollars in today spending money in 11 to 15 years with returns in the range of 2% to 6% real.

The net worth calculation favors tax-deferred investments into the IRA. Of course it does. The extra money from the tax deduction is put into the taxable account and the million dollar goal is reached about a year earlier.

Do we have our answer? Not necessarily.

Income taxes will be owed on at least a portion of the money in the tax deferred accounts, but not on the money in the Roth accounts. What can our friend do to avoid that tax, if anything?

 

The Role of Roth Conversions

 

If our friend chose to make only traditional contributions, he would end up with about $500,000 in the IRAs and $500,000 in a taxable account. We’re assuming he has invested in a tax-efficient manner, buying passive index funds to minimize tax drag.


In early retirement, our friend still has kids at home — that means he continues to have close to $30,000 from the standard deduction and exemptions, along with $2,000 in child tax credits.

Plugging numbers into Taxcaster once again, we find that he can report a full $40,000 in income per year to meet his family’s needs tax-free*. In fact, assuming his taxable account is invested in a tax-efficient manner, delivering about $10,000 in qualified dividends, he can withdraw closer to $50,000 before income tax is owed.

*Ahhh… but he can’t touch that IRA until age 59.5, you might be thinking. It’s true that he cannot withdraw the funds without a 10% penalty. But there’s no age (or income) limit on Roth conversions.

Our friend could live completely off the taxable account in the initial five years of early retirement, taking some long-term capital gains and still converting about $40,000 a year of the traditional IRA contributions to Roth contributions tax-free. After 5 years, the converted money can be accessed penalty free. Make annual conversions in this manner, while living off the taxable account, and you’ve set yourself up with a Roth conversion ladder.

 

We Have a Winner!

 

Like me, our aspiring early retiree friend should be making traditional, tax deferred contributions to his IRAs.

Stephen King claims to start a novel with a setting and a few characters with little idea where the story will take them. I tend to go into an exercise like this in a similar fashion. To be honest, I was hesitant to even write this post because a) I figured it would pretty much be a wash and b) the topic has been discussed exhaustively.

But lo and behold, it seems clear that in the case of my FIRE-minded friend, there is a clear winner. If he and his family continue to live happily ever after on $40,000 a year in today’s dollars, they will be in great shape to save money in a tax-deferred manner and access it essentially tax free as early retirees.

 

Yeah, But What About?

 

Health care? College costs? Braces?

Yes, there are many unknowns in his future. And yours. And mine. He may need a bit more money in the future. Maybe a lot more. To keep it somewhat simple, I haven’t addressed every possible cost that may rise or fall with the political tides.

To be honest, every assumption we made regarding future taxation is made based on current tax code, and the odds of no drastic changes in the next ten to fifteen years is slim. We simply do the best we can with the information we have today.

If it turns out he needs 50% more money than we calculated, he’ll adapt to the new nest egg goal and work either harder, smarter, or longer. Based on the numbers we used in the spreadsheet, an additional $500,000 would require an additional 5 years in the workforce. He’s still financially independent by 50.

 


You’re still not using Personal Capital? Track all your accounts in one place like I do.


 

Are you convinced? Should our friend eschew Roth contributions in favor of traditional tax-deferred IRA contributions? In what situation would you advocate the Roth route? Sound off below!

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50 comments

  • You put together a strong argument for using a traditional IRA.

    I think for me the main reason that I contribute to a Roth IRA is to diversify my tax situation for the future. I have no idea about taxes in the future and I am able to push my effective rate super low so it’s hard for me to think that I’ll be able to take advantage of these tax rates in the future.

    So I figured why not lock them in while I can now 🙂

    • Do you contribute some to tax-deferred accounts also?

      There are numerous personal factors that can change the equation, but the best of both worlds is to take a tax deduction now and make tax-free conversions to Roth in retirement like today’s subject should be able to do.

      Best,
      -PoF

  • Brett

    I disagree with traditional thinking on Roths when it comes to my 401k. My wife and I are both high income physicians and both do a Roth 401k. A traditional 401k may save me tax money now, but I am effectively saving more money by doing a Roth. To me a traditional 401k only makes sense if you have the discipline to invest the $7000 tax break you’re getting (14k if you count my wife’s). Otherwise you’re just saving less. In other words, the biggest factor contributing to my Roth decision is human behavior. We would spend that tax break on other things. Instead we will have an extra 14k per year in tax free money earring compounded interest (also tax free) for many years. It’s a big difference! Anyone else agree w me on this?

    • I have heard this too. That unless you are disciplined enough to invest the difference (the taxes you are not paying on the Traditional now) that it is better to invest in the Roth. Still I have decided to go with a traditional for a number of reasons outlined here.

      For me, the tax savings now and likelihood I will go part time in 10 years factor into it. I will be able to convert the money then at a lower tax rate. While the best situation would be to save more money as you imply above, this is a second best option.

    • Suzi

      I agree with Brett. Looking at it another way, in order to squeeze in under the tax bracket, presuming a desired income of $75,900 (which will invariably be adjusted later, but for purposes of this example, presume the above figure): If the money is in a Roth, then the drawdown will be exactly $75,900. In a traditional, the net figure would require a higher drawdown in order to cover taxes. The $14,000 invested will have to grow more to be worth the same net annual withdrawal later–since that doesn’t happen, more will have to be invested, or a taxable account will need to be tapped to make up the difference. It’s a bit different with ER before 59 1/2, but the Roth funds that are over 5 years aged can be drawn with no penalties at that point.
      Tax implications aside from 15 to 25 to 28% brackets, you’re literally investing more in a Roth because the (already-taxed) balance will be 100% available, whereas the traditional retirement vehicle has to grow to a much larger balance in order to provide the same (taxable) income in retirement. When maxing out a 401k, it’s nearly the equivalent of investing 15-28% more for the future to utilize a Roth than a traditional account. Similar to the argument of reducing fees in retirement accounts and how that can impact the long-term growth, if the seeds as well as growth will be taxed later, it reduces the sum total value of the account(s).

      • Brett

        Agree. 5 stars. I’m not clear why we seem to be in the minority with this thought process. Makes me question my own logic. But I’ve thought about it a lot! 25 years of tax free compounded interest!! And again… human behavior… themoney is easily accessible in my taxable vanguard account (which I don’t touch… but it’s still accessible). Once it’s in my Roth… it definitely won’t get touched.

      • Right, but in this example, the subject will have his cake and eat it, too.

        Tax-deductible contributions into a traditional & SiMPLE IRA now. Tax-free conversions of those dollars into Roth in retirement.

        The money he saves in taxes is invested in a taxable account, and it’s all free money that he wouldn’t have if he had invested directly with Roth contributions in the first place.

        If you end up with multiple millions in the taxable account, you may use up the exemptions and standard deduction with dividends, but that won’t be the case for this guy or most early retirees.

        Best,
        -PoF

    • Thanks for the comment, Brett.

      As a household with two high-income physicians, I find it surprising the “found money” from the tax deduction would be spent and not invested. If human behavior / psychology is the issue, there are many ways to overcome it. As The Grounded Engineer suggests below, you can automate a portion of your paycheck to automatically invest in a brokerage account. You could set up a budget, or simply pay yourself first and invest the rest.

      The best justification for Roth in your situation is that if you both plan on working 30+ years, you could end up with millions in your retirement accounts and RMDs at age 70 1/2 could put you in one of the higher tax brackets. I know very little of your situation, but my recommendation for physicians in the top tax brackets is to defer as much tax as possible and invest the difference. You can live very well on one high-income physician’s salary and save the other. Live on half and you should be financially independent in about 15 years if starting from scratch.

      Best,
      -PoF

      • Brett

        My wife will likely work another 20 years… myself another 25-30 years. I think the tax free compounded interest (as you said) is reason enough to do a Roth. I know it goes against traditional thinking with regards to future taxes. But 18k in a Roth is not equivalent to 18k in a traditional. And I’m eyeing the tax free payoff in the end. Plus we both get an employer match which allows for some tax diversification. I also still think human behavior is a good reason. Thanks for this blog! Love it!

    • I’m all tax-deferred as much as possible.

      Brett, you might be interested in analysis The Financial Buff did a couple of years ago where he came up with an estimate that the additional money you can shelter in a Roth 401(k) account is worth about 7 percentage points on the difference between your current marginal tax rate today and your expected marginal tax rate in retirement.

      In other words, if you’re in the 35% bracket today and expect to be in the 28% in retirement, the Roth starts to be the better option (because the tax arbitrage you get from saving at a high marginal rate today and paying a low marginal rate in the future starts to go away). If the gap between your marginal tax rate today and your marginal tax rate in retirement is greater than 7%, the traditional account wins (assuming as you rightly point out that the tax savings are invested each year). It’s a bit more nuanced than that (plus many other factors) but a helpful guiding post nonetheless.

      For some of us in high tax locations (like NYC), I find it hard to believe that the spread will be 7% or less but, if it were, that would be a good problem to have.

      There’s even a spreadsheet where you can play with the numbers yourself if curious.

      https://thefinancebuff.com/roth-401k-for-people-who-contribute-max.html

  • Great exercise, POF! You probably know I’m a fan of the traditional 401k from my “Screw the Roth” post. Those ROTH dollars are really tempting, but you’re giving up the tax arbitrage opportunity. I did make some ROTH 401k contributions early in my career, but it was before I did the math and learned about the ROTH conversion ladder. Tax optimizations can make a massive difference 🙂

    Cheers!

  • SG

    Ill toss out a third scenario. POF, if you do intend to retire early (I know big if), have you considered tax gain harvesting? I think that would beat out the roth option if you were able to successfully do it. I think the big question is can you stay in the 15% bracket based off annual expenses. I was recently introduced to the idea this weekend. Seems like an unbelievable deal for people that become FI early, have costs under control, and discipline to perform it. If early retirement is the goal it seems that using traditional 401k save taxes now, performing a Roth conversion ladder once retired (minimize taxes later and allow access to money earlier), and tax gain harvesting (essentially free step up in basis later) would make a lot more sense than a roth option now. This would only apply to people who want to reach FI and retire early, who can live a life where expenses would place them in the 15% bracket. This seems unbelievably attractive to me, however I just don’t know if I will want to retire early. For now I do traditional 401k and backdoor roth IRA.

    • Good thought, SG.

      TGH will be a great strategy for some, but I’d rather avoid income tax by converting to Roth than avoid potential future capital gains taxes by tax gain harvesting.

      There are several reasons and they are individualized to my portfolio / strategy.
      1. I’ve got plenty of carryover losses from tax loss harvesting (which can be used to offset income taxes). Tax gain harvesting would just offset the previous losses carried over.
      2. My strategy to keep potential capital gains smaller is to donate funds with the highest gains to our donor advised funds.
      3. Income taxes are generally higher than capital gains taxes. Converting to Roth in retirement will allow me to avoid RMDs (unless RMDs are forced on Roth, which has been tossed around).

      I’ll also point out that you can have expenses far above $75,000 and still pay no income tax. It’s all about taxable income — if you’re spending from taxable and / or Roth accounts, you’ll have very little taxable income — if you retire with kids at home, you have the benefit of the exemptions and child tax credits.

      Best,
      -PoF

  • Thanks for running the numbers on this, PoF! I fell into the same chain of thought that Roths were in most cases better than Traditional. I’ll be re-running the numbers for my situation tonight to see what makes the most sense.

    Brett, I understand what you are saying about human behavior. However, to achieve FIRE you need discipline. If you budget and invest into a traditional 401(k), you can automate your savings so you invest the $7,000 tax break you’ll receive.

    • It sounds like Brett’s not necessarily interested in FIRE. The further out your retirement (2 to 3 decades for him), the more unknowns there are.

      I’ll be interested to hear if you end up making any changes in your contribution strategy.

      Best,
      -PoF

  • I read a book once (forgot the title) making the argument the Roth was better in all circumstances, but I just couldn’t convince myself to believe it. My default position is that once yo are in the 25% bracket traditional is the way to go. If the US ever replaces the income tax with a European style VAT there are going to be a lot of angry Roth IRA holders.

  • While I might agree with using a traditional to limbo under a tax bracket change at 15-25 percent, I don’t otherwise agree. A Roth gives you diversity in tax situation. Along with your 401k your covered if the government changes the brackets or changes the laws. After all the tax laws in the 70s were orders of magnitude higher then today.

    • Nothing wrong with some tax diversification — I’ve got plenty with half of my $ in a taxable account and that whopping Mega Roth conversion that I did (and in hindsight, don’t think I’d do again).

      A small point — an order of magnitude = 10x. I hope nobody was paying 400% to 500% marginal tax rates in the 70s!

      Best,
      -PoF

  • The only Roth contributions I make are also through backdoor conversions as well. Thought it was a no-brainer and never put anytime into reading any more about it. But now I’m curious to read Mr. Crazy Kicks’ post & the Roth Conversion Ladder. Thanks for bringing the subject to light…

    • The more likely you are to retire early-ish, and the less likely you are to have massive tax-deferred balances, the more traditional contributions make sense. Add in California tax rates and it’s a clear choice.

      Cheers!
      -PoF

  • Gary E Kolb

    I would bet that with our big spending congress and high federal deficit that taxes will have tobe higher in the future. Therefore never taxed instead of higher taxed makes a strong case for paying the tax today

    • Even if rates go up, I expect to be several brackets down as an early retiree. If they throw out the tax code and start from scratch, this entire post and conversation will have been for naught. Time will tell.

      Cheers!
      -PoF

  • I’m a low 6-figures earner at $125,000 salary. I can’t get my income low enough to make Traditional IRA contributions that are deductible, so I keep contributing to my Roth IRA because I’m easily under the deductible limit.

    When I get married next year, our gross income will be around $180,000 so we won’t realistically have the opportunity to make traditional IRA contributions either, even with children.

    The optimal scenario where you can take advantage of all the crazy tax deductions is if your household income is around $120,000 and you have 2 children. Deduct $36,000 in 401k contributions, $20,000 in parental deductions/exemptions, plus another $10,000 in deductions for your 2 children. This brings your MAGI down from $120,000 to $54,000. Now you can also deduct $11,000 for Traditional IRA contributions bringing your MAGI down to $43,000. This assumes that you don’t itemize your deductions for even more savings.

    • Yes, that is an incredible setup.

      Of course, most couples with that income won’t have the discipline to max out two 401(k)s and two IRAs (and perhaps an HSA). But if you do, your annual tax bill will be tiny.

      I’m not going to complain, but the only way to get my income tax bill under six figures is to donate a six-figure sum.

      Cheers!
      -PoF

      • Paul

        You’ve described my impending situation almost perfectly. Resident, 2 kids, spouse about to start working with a solid income. Combined income likely $130-140k starting next year in a low cost of living area. Trying to plan out my strategy of to Roth or not to Roth once her income knocks us up to the next tax bracket next year. We’ve maxed Roths the last 2 years. We also have ~$35k in traditional that I am considering converting to Roth this year while our tax rate is still low.

        David, I hadn’t thought of it that way before, that we’re in the sweet spot to lower AGI. We are living like residents, and I suppose maxing out 401k ($36k) will be possible for us. We’ll also be paying for childcare with FSAs.

        The major difference of course is my student loans ($180k). I’m on REPAYE so I don’t see any sense in throwing more than the minimum ($100/month) at them for the next 18 months, given that with REPAYE I have an effective interest rate of ~3.5% after the subsidy. That said, I can’t deny it would be nice psychologically to substantially reduce that number before I finish residency.

        Any advice out there for our situation as far as Roth or not, maxing out HSAs, loans vs retirement, Roth conversions, etc? You all are the best. Thanks.

    • Paul

      You’ve described my impending situation almost perfectly. Resident, 2 kids, spouse about to start working with a solid income. Combined income likely $130-140k starting next year in a low cost of living area. Trying to plan out my strategy of to Roth or not to Roth once her income knocks us up to the next tax bracket next year. We’ve maxed Roths the last 2 years. We also have ~$35k in traditional that I am considering converting to Roth this year while our tax rate is still low.

      David, I hadn’t thought of it that way before, that we’re in the sweet spot to lower AGI. We are living like residents, and I suppose maxing out 401k ($36k) will be possible for us. We’ll also be paying for childcare with FSAs.

      The major difference of course is my student loans ($180k). I’m on REPAYE so I don’t see any sense in throwing more than the minimum ($100/month) at them for the next 18 months, given that with REPAYE I have an effective interest rate of ~3.5% after the subsidy. That said, I can’t deny it would be nice psychologically to substantially reduce that number before I finish residency.

      Any advice for our situation as far as Roth or not, maxing out HSAs, loans vs retirement, Roth conversions, etc? You all are the best. Thanks.

  • Great analysis, PoF!

    Unfortunately for me, I make over the deduction limit for the Traditional IRA, so I only contribute to do the Backdoor ROTH IRA.

    However, having a ROTH would give diversity to an individual’s tax situation, and may be useful to have in some scenarios.

  • These types of thought exercises are always interesting to me, but at the end of the day they involve many assumptions, and we all know what happens when you ASS-U-ME.

    Rather than trying to optimize around a bunch of assumptions you don’t know and many of which you can not control, we plan around things we do know and can control.
    -Develop a high savings rate by both increasing earning and decreasing spending.
    -Max out tax deferrals (401(k) and HSA)
    -Max out Roth (Regular or back-door)
    -Invest in taxable accounts.
    -Control investment costs
    -Learn to manage your behavior

    If you do this, you will have plenty of diversification among account types and options for flexibility. For me, the best plan is the plan that gives the most options.

  • You can call me crazy, but the reason I Roth at every opportunity (currently a Roth 403b and backdoor Roth IRAs x 2) is that I can afford to pay the taxes now without impacting my lifestyle. I pay them now, and know that barring a change in the law/tax code I never have to worry about them again!

  • We started off with a Roth, but switched over to a Traditional a few years ago…for the exact reasons outlined in this post. I think the numbers speak for themselves. Our income will be less in retirement, so it makes sense to delay the taxes. That said, I do understand the desire to diversify taxes later on…

    • Smart play, Amanda.

      There will be time for Roth conversions when you’re jobless by choice. That’s the time to start building up the Roth balances. Especially if you can do so for free.

      Cheers!
      -PoF

  • Jacq

    Without the in-depth analysis you’ve done (thank you!), I contribute to my 401k and Roth, figuring it hedges my bets on taxable income in retirement.

    • You make an excellent point, Jacq.

      So often in personal finance, we present a false dichotomy. It doesn’t have to be either / or, especially with the many future unknowns.

      Cheers!
      -PoF

  • You are exactly right with this. When I first started saving for retirement I had planned on retiring when I was 65-70 and having 10 million dollars. Now I’m trying to retire at 40 with a much much lower income than I currently have.

    People will say we don’t know about future tax brackets so better to pay now while you can. But by that token there is no guarantee the government won’t tax Roth money. Just two years ago Obama proposed taxing 529 college savings which are supposed to be protected the same as a Roth.

  • After listening to Dave Ramsey I started doing Roth 401(k) contributions, I was happy knowing that all my investments are tax free for “evah” But being in a high tax bracket and living in CA I wasn’t happy about paying to much money in taxes. One day I found about Roth IRA ladder and other tax efficient ways for investment I turned 180 and now we are using more and more Traditional, pre-tax vehicles.

  • Ari

    Good stuff here and an interesting strategy laid out here. I agree for the most part, but I think there are simply to many assumptions to be made to have a “right answer” for someone 10-20 years away from retirement. I like to play the tax fence, and am shooting for a somewhat balanced split between traditional and Roth accounts. I recently read the current admin is looking at completely cutting the pre-tax option, and I suspect major tax overhaul will vastly change the outlook of much of this analysis in the somewhat near future. One part I think is important for someone closer to retirement is the no RMDs with the Roth, a huge traditional account will force you to be in a higher tax bracket at some point in retirement which is a misunderstood concept by some.

    http://www.benefitspro.com/2017/04/13/gop-contemplating-shift-to-all-roth-401k-system

  • Mike

    I’m basically in the exact same shoes as your theoretical example and your tax rates are way too high. My taxable income comes out around the $50k -$60k range after 401k deductions come out which puts me firmly in the 15% bracket.

    I use the Roth because the benefit of dropping into the 10% bracket in retirement is only 5%. Plus, having a lower taxable income since a lot is coming from Roth can be useful for qualifying for some benefits if needed. It also gives me some flexibility, maybe I’ll work a side job or start a business or something and end up making a lot more than I planned after I’m “retired.” Perhaps I’ll just keep going and aim for being rich.

    There are a lot of ways I could end up still in the 15% bracket and unless I can’t fill up the 10% bracket somehow, there’s really no downside. I might as well eat the taxes while the sum is small. The same goes for tax gain harvesting if you are in the 15% bracket, you might as well fill it up with long term capital gains taxed at 0% so that you don’t end up paying that tax later when your rate is higher.

    • That’s awesome that you can bring the income down that low. Our friend in this example doesn’t have a 401(k) and his spouse doesn’t either.

      Tax gain harvesting is another no-brainer in your situation.

      If you plan to stay in the low tax brackets in retirement, you may have the opportunity to make tax-free Roth conversions later on. Just keep that in mind. It’s better to take a small deduction now if the contribution is going to end up as Roth money eventually, and at no cost.

      Best,
      -PoF

  • Your example is close to our situation. We’re a low 6 figure household with 4 kids. We used to contribute all Roth, but I recently switched to all traditional. At this point, we don’t expect to have a high income in retirement, so our taxes will be low and there is the option for a Roth ladder as you discussed. I wrote a post a few weeks ago that shows the effective tax rates when the child tax credit is taken into account for various family sizes. Basically, make sure you are getting the entire credit and not over-contributing to a traditional if you don’t have a high PoF income, which applies to all non-refundable credits.

  • PoF, this is an awesome post!

    I have had to talk my wife into a Traditional over a Roth for us. We are pretty close to your example. Everyone it seems has just been told go with a Roth over anything else because, tax free duh. Really misleads a lot of earners in and around this income range.

    Thanks for the detailed post and analysis.

  • Joe

    Would you still apply this ideology for a married physician-in-training couple who aren’t specifically looking to retire early? I’m military so I already have the tax benefits of non-taxable entitlements while my wife is beginning residency. We’re well aware that this will be the lowest tax bracket we will be in until retirement. My wife is fairly confident in a full career in either academic or administrative medicine. For myself, I’m planning orthopaedic surgery with potentially part-time at around age 55+. This sounds like the most logical time to accept the 25% tax on a Roth, especially with 30+ years of growth tax-free (we’re both 27). I know YMMV may vary but I had all but committed on the Roth until this article yet again made me revisit this issue.

    • In your case Joe, Roth contributions probably make the most sense. If you work as an orthopedic surgeon for 25 to 30 years and your wife works as a physician too, you might have a huge tax-deferred stockpile, so I’d get some Roth dollars while they’re cheap. Your situation is very different from the one presented here, but it’s smart to consider and reconsider all your options.

      Best,
      -PoF

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