SVIC Facebook Q&A Discussion:
Roth 401k/IRA vs Traditional
Question for the group:
*This question was asked to the community last December 13, 2022:
Why do tech industry people in California use Roth 401k/IRA instead of traditional? Unless I’m missing something—you’re already in the highest tax bracket so your tax bracket post-retirement cannot be higher, it can only be the same or lower, so you might as well use traditional?
Also, you could move outside California post-retirement and save on the state tax? Please educate me if there are other advantages of Roth. Thanks!
Community Answers:
Answer #1: Tax-free
“One reason to do this is that any investment gains over the many years before retirement can be distributed tax free from a Roth.” —SVIC Member
Answer #2: You may withdraw any money you put in at any time
“Roth also allows you to withdraw any money you put in at any time tax and penalty free. And after 5 years you can withdraw your gains penalty free (still have to pay taxes though. Unless you’re at retirement age).
So I think if you want to retire early then the Roth has the advantage.” —SVIC Member
Answer #3: No capital gains tax
“No capital gains tax. Most are young and have 30+ years of investment in front of them” —SVIC Member
Answer #4: Converting to Roth is worthwhile at your your current tax bracket
“Hey fam, there is one thing no one mentioned. If you are Married Filing Jointly now, it is very likely that at some point in your lives (hopefully many years from now), one of you will pass away before the other. If that happens, your tax rate effectively goes up. This compounds as RMDs go up.
What that means is that converting to Roth is worthwhile at your your current tax bracket.” —SVIC Member
Answer #5: Investing capability
“From my (anecdotal) friends that use Roth IRA, i was told that, they believe their investing capability is so awesome they are going to achieve amazing returns (like 1 million bagger in 30 years) and they don’t like the thoughts that evil IRS take any dime out of their awesome gain. But like someone pointed out, with the same awesome investor with 1,000,000 X return, the output in 30 years might be the same assuming the same tax rate and same tax bracket rule.” —SVIC Member
Answer #6: Both!
“I think people do both? Traditional first and Roth (conversion from after tax aka mega back door) second.” —SVIC Member
“As long as you meet eligibility requirements, such as having earned income, you can contribute to both a Roth and a traditional IRA. How much you contribute to each is up to you, as long as you don’t exceed the combined annual contribution limit of $6,500 or $7,500 if you’re 50 or older.” —SVIC Member
“I think many would still do pre-tax contribution first.
However, many tech workers I know do take advantage of the backdoor and mega backdoor tricks after maxing out pre-tax 401k as they can afford to do so. After all, if one is investing post-tax money anyways, why not do a roth conversion and get the growth tax free (with current tax law)?
Some companies also offer a brokerage option for 401k plans and one can invest in most things that do not involve margin. So, one can buy GME at under $1 or over $81 and sell today without triggering capital gain / loss tax.” —SVIC Member
Answer #7: Depends on the income during the year
“If you are having a very high income year, it’s probably better to use the traditional IRA and take the tax deduction. But even high earners have years when they can’t use the tax deduction so the Roth is preferable–we also don’t know where tax rates are headed so I prefer the Roth which:
1) Grows and distributes tax free; and
2) Roth IRAs do not require withdrawals until after the death of the owner. So they are more flexible and you can leave money to heirs” —SVIC Member
Answer #8: No RMDs, huge sum
“One advantage is no RMDs (Required Minimum Distributions) so if you want to leave the Roth to a beneficiary they get it tax free.
Answer #9: Works out the same?
“But you start with proportionally less capital, so it works out the same, no? Let’s say the tax rate is 50% for simplicity and you make 900% gains before retirement
Traditonal: $1000 -> $10000 -> take distributions and pay tax -> $5000
OR
Roth: Pay taxes now -> $500 -> $5000 -> take distribution tax free -> $5000” —SVIC Member
Answer #10: Tried both
“I had the exact same question in my head many years ago. Long story short, I went with 2/3rds regular 401K, and 1/3rd Roth. I figure my tax liability is likely to be lower on most years, but if I ever need to do a big home renovation, or help somebody with money, or who know what large expenditure, I have the flexibility to do it without bumping up my tax liability.” —SVIC Member
Answer #11: Big numbers go up! No taxes? Yes please!
“All good answers so far! My low IQ answers:
1. When I was in my 20s, I saw someone at Google post a deck that said to use the Roth IRA instead of the traditional 401k, so I just copied them. 10 years later I haven’t researched anything material that warrants a change.
2. This guy turned $2000 into $50M. Now it’s tax free when he retires: read article here.
Big numbers go up! No taxes? Yes please!” —SVIC Member
Answer #12: The fallacy that all people in tech are in the highest income bracket
“Just want to mention the fallacy that all people in tech are in the highest income bracket. I definitely have a long way to go to hit that top bracket. Especially in my current state of working for a pre-IPO company with over half my comp package not being liquid.” —SVIC Member
Answer #13: Maxing out savings
“I think it’s because many people max out their savings. If you can totally max everything out, it means that you’ll end up with more later on if you used Roth, because you won’t have to pay taxes on it.” —SVIC Member
Another advantage is if you expect to have a huge sum in your 401K. Reportedly Senator Mitt Romney (and I expect others) did this when he was at Bain. They put stock in companies they had invested in (alongside Bain as a company) and reportedly his 401K is worth North of 200 million dollars. Imagine if you are a founder or very early employee and could put founders shares into a Roth 401K at par value? So there are special cases.
Personally, for high income individuals generally, I would have a mix of regular and tax advantaged accounts. (I do).” —SVIC Member
Answer #14: Tax rates can change
“Something I think nobody pointed out is that tax rates can change. It could be a bet that even if they’re in the highest tax bracket now and in retirement, the overall tax rate will be lower now than then” —SVIC Member
Answer #15: Roth lets you put in more effective pretax money in
“It’s not just about the absolute tax rate between now and later. Roth lets you put in more effective pretax money in, as the limit number is the same between the two but the Roth is taxed before counting against the limit.
Also, even if you’re in the highest tax bracket now, the amount of taxation on that highest tax bracket is actually quite low compared to some points in history.” —SVIC Member
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