Roth, Traditional, After tax?

• Roth, Traditional, After tax?
  • Roth
  • Traditional
  • After tax
  • Which do I prioritize?

Roth

Roth (a senator’s last name, not an acronym, please don’t say ROTH) is a tax treatment that is not tax deductible in the present, but all gains and the original contributions are not taxed on the back end. Roth is available in 401(k)s and IRAs (and other accounts, but these are most common).

There is additional benefit in which contributions to such accounts can be withdrawn tax free, and in some cases, penalty free.

In addition, when withdrawing from Roth, the withdrawals do not count towards AGI for tax purposes. This means you can lower your taxable income by relying on Roth (i.e. when paying federal taxes, you can lower your highest marginal tax rate by pulling more from Roth than other forms of income).

Traditional

Traditional tax treatment of accounts is taking pre-tax dollars and deferring taxation of those contributions to when it is withdrawn from those accounts. Another behavior of traditional accounts is contributing post-tax dollars and then deducting them during tax filings (i.e. traditional IRA).

Traditional accounts have an added caveat of required minimum distributions, which are forced withdrawals. RMD’s are mandated to ensure that the government can collect the taxes that were ultimately deferred. This complication is something that needs to be considered in withdrawal strategies, or by converting traditional sources into Roth IRAs, which are not subject to RMDs.

After tax

This is a special bucket of money that is taxed on the front end and the gains in this type would be taxed on the withdrawal (however, see Mega-backdoor Roth).

In addition, there is also the concept of after-tax investing in a brokerage account. This is more flexible than 401k/IRA or other tax advantaged accounts, as you can withdraw the investments from the account at any time without penalty. These investments, however, are less tax efficient as you are taxed on the income it took to fund it, as well as the dividends and any capital gains realized.

Hypothetically, if a person would receive $2000 in gross income and $1500 in take-home pay after benefits and taxes, after-tax contributions would work as follows.

Contribution %	Amount put into after-tax	Take-home
25%	$500	$1,000
50%	$1,000	$500
75%	$1,500	$0
100%	$1,500	$0

Which do I prioritize?

Nobody can predict future tax treatment, or whether the future country will treat Roth the way they promise (although changing retirement income would be political suicide…). So, if you are in a high tax bracket (i.e. 24%+), traditional is a pretty safe bet.

The key thing to evaluate for your individual scenario, is to look at your current tax bracket and consider what your retirement income picture looks like. Traditional wins if your tax bracket is presumed to be lower in retirement than your tax bracket is today. Roth wins if your tax bracket is presumed higher in retirement than it is today.

In addition, I advocate for Traditional investments where you can at higher income levels because there is a limited number. Married couples who make more than $136,000 combined cannot deduct a single dollar of traditional IRA contributions, for instance. This leaves only sources like 401(k)s and HSA contributions that are tax deductible for high earners.

On the other hand, you have $6,500 of Roth IRA space (see Backdoor Roth IRA) and tens of thousands of dollars in Mega-backdoor Roth 401k space.

All in all, do the math. Only you know your full tax picture, goals, timelines, etc.