taxable vs. 401k vs. roth

[pedsmd]

I'm trying to make sure I understand the differences between the various retirement investment types for a lecture I have to give to some residents. I realize these numbers are artificial but I'm trying to make the math work:

Assume Tax rate now: 20%,  tax rate later 30% cap gains rate 15%  investment return: 7.2% time frame 10 years (double the money)

$1500 of money pretax investment:

Roth: $1500-300 taxes = $1200 invested (after taxes) --> $2400 after 10 years

pretax 401k/403b/etc: $1500 --> 1500 invested --> 3000 -900 (taxes) --> $2100 after 10 years

taxable: $1200 invested --> 2400 - 360 (capital gains) = $2040

This assumes investing in stock based mutual funds. I guess the point I'm trying to show is why they should invest in a roth followed by pretax stuff followed taxable as a resident. (obviously after paying debt, taking into account student loans, etc, etc, etc. jsut focusing on the investment piece for this section)

Does that make sense?

[Peds]

your scenario is only correct because your future tax rate is higher than the present.

if that scenario reverses, then you are wrong.

if that tax rates do not change, then pretax/roth are equal.

dont forget taxable is taxed yearly, not just LTCG. which also could be zero in retirement.

 

basically you made a scenario where you are correct.

[jfoxcpacfp]

I think the piece you're missing is what they will have to pay in taxes later when they become attendings and how the results shift. That will make the impact that they need to take advantage of Roth contributions now. (I didn't check your math.)

Another point I would make is that these examples assume the taxpayer will invest the savings resulting from making tax deductible contributions when they are in a higher bracket. If the taxes saved just disappear into cash flow, they might as well stick with Roth contributions. That opinion does not seem to be very popular around here, though.

 

[pedsmd]

Peds wrote:

your scenario is only correct because your future tax rate is higher than the present.

if that scenario reverses, then you are wrong.

if that tax rates do not change, then pretax/roth are equal.

dont forget taxable is taxed yearly, not just LTCG. which also could be zero in retirement.

 

basically you made a scenario where you are correct.

Click to expand...

I wasn't trying to prove a point per se, but just make sure I have my facts straight.  I would imagine that those of us doing the backdoor roths are really just saving on the capital gains since the tax rates are going to be later and we do not have any other pre-tax investments left. I guess it's not an either-or but an all of the above.

[jacoavlu]

Don't forget to consider a possible match on contribution to a pretax account

[Peds]

pedsmd wrote:

Peds wrote:

your scenario is only correct because your future tax rate is higher than the present.

if that scenario reverses, then you are wrong.

if that tax rates do not change, then pretax/roth are equal.

dont forget taxable is taxed yearly, not just LTCG. which also could be zero in retirement.

 

basically you made a scenario where you are correct.

Click to expand…

I wasn’t trying to prove a point per se, but just make sure I have my facts straight.  I would imagine that those of us doing the backdoor roths are really just saving on the capital gains since the tax rates are going to be later and we do not have any other pre-tax investments left. I guess it’s not an either-or but an all of the above.

Click to expand...

You said you were trying to show Roth was better than other options. Sometimes it is, sometimes it's not. What about married two income residents in CA with no house or kids?....

[CordMcNally]

pedsmd wrote:

This assumes investing in stock based mutual funds. I guess the point I’m trying to show is why they should invest in a roth followed by pretax stuff followed taxable as a resident. (obviously after paying debt, taking into account student loans, etc, etc, etc. jsut focusing on the investment piece for this section)

Does that make sense?

Click to expand...

As a general rule of thumb for residents, I would recommend investing up to the match in your pre-tax accounts, maxing the Roth IRA, investing the entire max in your pre-tax accounts, then taxable. Not very many residents are going to get to taxable unless they have a high income spouse. An HSA would also be in there but since you didn't mention it, I left it out. An employee match is free money and a guaranteed return. Roth IRA space is valuable and limited. The tax rate of a resident is typically low so that's why it comes behind the pre-tax match and Roth IRA.

[StarTrekDoc]

It's a good start to the savings portion of the complex issue of finances as residents and early career docs.

I think the majority of said talk would concentrate more 'living like a resident', debt servicing strategies, and then target savings rates --- and the most appropriate vehicles for that institution (ie matching vehicles take 1st position).

you can through in 'exceptions' like those pointed out earlier for no debt, dual incomes, high deduction folk