To Roth or not to Roth… that is the question. We get asked this all the time by our clients.
And we always answer with question: will your tax bracket be higher now, or in retirement?
If it’ll be higher now, then DON’T do a Roth.
If it’ll be higher in retirement, then DO do a Roth.
It’s that simple.
A Roth (IRA or 401k) allows you to pay taxes now instead of later.
So pay your taxes whenever your tax bracket will be lowest.
If your tax bracket will be lower in the future, pay your taxes then. Or if your taxes are lower now, then pay your taxes now by contributing to a Roth.
But wait a minute, what about the tax-free growth that comes with a Roth?
That’s gotta be worth something, right?
Nope. Doesn’t make a lick of difference.
Once you put money into a Roth, it grows tax-free forever. You never ever pay taxes on that money again. Surely, paying taxes on a small amount now is better than paying taxes on a big amount later.
It seems intuitive. Except it’s not correct.
To prove I’m not taking crazy pills, here’s some very simple (I promise) math:
You have $10,000 to put in a Roth 401k or a Traditional 401k.
TO ROTH: To put it in the Roth, you must pay taxes on it first – let’s say 20%. So $8,000 actually goes into the Roth. It doubles over the next 10 years, and now you’ve got $16,000.
Simple.
NOT TO ROTH: If you put it in a Traditional 401k instead, you don’t pay any taxes now. So all $10,000 goes in. It doubles in 10 years to $20,000. But NOW you’ve got to pay your 20% in taxes… which, drum roll… leaves you with $16,000.
!?!?!?!?! *mind explodes*
So, to come full circle: the only consideration when deciding “To Roth or Not to Roth” is whether your tax bracket will be higher now or later.
P.S. This does not apply when considering a non-deductible Traditional IRA vs. a Roth IRA. For that one, talk to your guy/gal. Don’t have one? Then contact us!
