I made a spreadsheet to calculate returns from investing in Roth and traditional versions of 401ks and IRAs. I did this because it's a recurring topic of confusion on the part of newbies (which is totally understandable) but also of debate among well-meaning people.
One piece of traditional wisdom has been that it's largely a wash, relying on commutative arithmetic with tax rates and an often-uncommunicated assumption that those rates won't change during the lifetime of the saver/retiree. Another is that one should use traditional accounts to improve tax efficiency anyway, and that the rest of it is a wash. As I hope the spreadsheet helps to make clear, these are (at least often) untrue, and the devil's in the details.
I used the spreadsheet to test out some of my own ideas, which generally skew in favor of Roth accounts:
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Future tax rates may well be hiked, making Roth options far safer for guaranteed retirement income
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For lower earners, this makes extra sense because they're in very low tax brackets anyway to start with
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For higher earners, Roth should be the default option when maxing out because of the greater concentration of earnings in tax-advantaged accounts
I expected to find that Roth was generally better at low and high ends of the earnings spectrum, but was surprised to find it generally better in the middle too. I'm open to suggestions for improving the tool, and would enjoy discussion of the results.
Using the spreadsheet
The spreadsheet's intended to give a rough picture of how the account types perform, including when matched in different combinations. Some features:
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In general, the quickest way to see the effects of different choices is to change settings in the left panel or in the first year's row. Try setting different combinations such as age, starting income, etc. and view the results in the grey bolded subcolumn below.
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Most settings controlling contributions, earnings and withdrawals for a particular year can be changed in that year's row, which by default also alters following years for that column
- This allows modeling the effect of tax hikes, etc. as well as market disruptions (sequence of return risks)
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The contribution model of company-match-first, then max-IRA, then max-401k, then (optional) overflow-to-taxable-account is followed.
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To make comparisons fair, savings percentages are evaluated pre-tax, but Roth contributions to both 401ks and IRAs are tax-adjusted to take up more of the savings percentage, i.e. exhaust it earlier
- This means that to max out Roth contributions, you must set the savings percentage high enough
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Variable inflation rates are allowed, and one can calculate inflation-adjusted earnings as well as contribution limits
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Returns are shown in projected future un-adjusted as well as inflation-adjusted dollars
Quirks and known issues
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There is no current support for including Social Security projected earnings in retirement income projections
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There is no direct support for rolling from a traditional to a Roth account (though one could mock this up by manually setting various dollar values for a particular year, with the caveat that this would disrupt auto-calculations for the edited cells). Instead, in rollover years traditional 401k contents are rolled to the traditional IRA, and Roth 401k contents are rolled to the Roth IRA.
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Modeling a glide path, and differential returns after retirement when the focus shifts to retaining wealth and generating stable income, is best done currently by manually adjusting settings on individual years
Submitted August 02, 2021 at 09:55AM by jeff_varszegi https://ift.tt/2V6yUhv
