• Danny Lee, CFP®, CRPC®

The Sad and Honest Truth about Traditional and Roth IRA...

Updated: Mar 26

I want to make this clear because if I don't, I'll get demolished by some. 😂


So here it is:

  1. We can't predict the future, I think.

  2. We can make assumptions, some with more confidence than others. (📖 CFA: Quantitative Methods)

  3. Just interesting - numbers don't lie.

Deciding between a Traditional or Roth IRA, doesn't matter. Keeping all variables the same (e.g., years invested, contributions, market returns, tax rates); one is not better than the other unless you can confidently predict the future - specifically tax rates. Yes, we can make assumptions about future outcomes with confidence, but we can't be 100% certain. (e.g., taxes, market returns, tax deductions, tax credits, personal financial situation, etc.)


Many financial advisors can relate, but we are often asked, should I open/invest in a traditional IRA or Roth IRA? At that point, our 🧠 (the advisor) is spinning, ready to uncover; do you have a job, you single or married, how much money do you make, do you have a 401k, etc.?


The person asking believes it a simple question and expects a quick response - Traditional or Roth? To the person asking → we can't assume. There are many rules and limitations when talking about IRAs. First, we need to make sure that you're even eligible to invest in an IRA; not all can. If you're eligible then the question is, which is better for me - Traditional or Roth IRA? It gets tricky because the client, and maybe the advisor, need to start making some assumptions about the future, such as income level, tax rates, tax rules, health, and many others. Plus, longer the time horizon, even harder to assume with confidence. Let's take COVID-19, who would have predicted a pandemic in 2020. They first identified COVID-19 in China, December 2019, the first case identified n the U.S, January 2020, market sell-off and start of the recession, February 2020. What's next? What are the future effects? Unknown...


The picture below shows the highest federal marginal individual income rate from 1913-2018. During the later 40's and '50s, the highest marginal tax rate was over 90% (their is a difference between marginal tax vs. effective tax). Future tax rates? Unknown...



So, when running a simple calculation, with "future assumptions" being unknown, unchanged (let's just assume, for fun 🥴), the ending account value is the same regardless of investing in a Traditional or Roth. No financial benefit. A popular saying, "do you want to be taxed on the seed or the harvest," you should reply, what will the tax be on the seed and the harvest?



Final Thoughts ❓

Looking at JUST THE NUMBERS and NOT MAKING FUTURE ASSUMPTIONS 🤔. If tax rates remain unchanged throughout our lifetime, deciding between a Roth and Traditional is irrelevant.


Of course, we can assume, some cases with confidences but let's be honest, we can't predict the future. If you're confident that you'll be in a higher tax bracket in the future, a Roth IRA will make more sense. Why? Pay tax now, at the lower rate, vs. paying tax later, at the higher tax rate. Traditional IRA would be the better option if the opposite. Delay paying taxes at the higher rate now, to pay later, at the lower rate. So, if you can confidently predict the constantly changing tax rules (graph above) and time it, you have your answer, and shoot me a call ☎️, would love to know.


Disclaimer: The blog content of Modern Millennial Wealth LLC (“MMW”) is provided for informational purposes only and is not intended to constitute financial or investment advice. At times, MMW blogs will share personal experiences and that information shared is intended to be general in nature and should not be relied upon as personal financial advice. You should not rely upon any information contained on this blog for financial or investment advice. Reading MMW blog(s) is not intended to and shall not create an advisory relationship between you and Modern Millennial Wealth LLC. Neither Danny Lee, nor Modern Millennial Wealth LLC makes any representation or guarantee about the accuracy of the information contained in this blog or links to other websites. Neither Danny Lee, Modern Millennial Wealth LLC., nor anyone acting on their behalf, will be liable under any circumstances for damages of any kind.


Sources:

https://www.taxpolicycenter.org/briefing-book/how-do-federal-income-tax-rates-work


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