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Don't "Roth" Everything

You’d be crazy to contribute money to a traditional IRA or 401(k) - right? We all saw what the government did during COVID, the Trump tax cuts, and all this other stimulus spending - tax rates can only go one way, and that is UP!

I hear a lot of this, and I think it is lazy planning when it comes from a financial professional. Sorry!

Taxes go way beyond higher or lower - that is too binary for a progressive system that has (currently) seven different progressions, or in this case, tax brackets.

Let’s talk about it.

The Progressive System

I feel like this alone pokes holes in the argument for “taxes are only going up”. I don’t doubt that is a serious possibility (although it has been said for decades and hasn’t actually happened).

But when I say progressive, I’m talking about the current tax system where all your dollars are not taxed at the same rate. As your income goes up, your NEXT DOLLAR may be taxed higher, but ALL YOUR DOLLARS are not.

I think the best way to answer this is with an example. Lets take a single, 35 year old physician making $300k in 2023 - her name is Jane. Here are the 2023 single tax brackets:

$300k is Jane’s gross income - there are deductions that lower her gross income to get to taxable income, or how much income is used on the tax table above. Some examples of those deductions for Jane include:

  • $1,500 in medical, dental and vision insurance premiums through her employer

  • $3,850 in Health Savings Account contributions

  • $13,850 standard deduction

Now Jane's taxable income is down to $280,800. Jane is still pretty safely in the 35% tax bracket, as you can see in the tax table above. Now comes the decision with her retirement accounts - does she use pre-tax to get a deduction that lowers her taxable income, or pre-pay her tax by contributing to Roth?

Jane has access to a 401(k), with a maximum individual contribution of $22,500 per year. If she makes that contribution, she will remain in the 35% tax bracket (since it won’t lower her taxable income below the starting 35% bracket income of $231,251).

$22,500 x 35% = $7,875. Doing a pre-tax contribution defers almost $8k in federal income taxes. If she makes the $22,500 in Roth contributions, she would pre-pay the ~$8k of tax, in exchange for never being taxed on that money again.


An important item to highlight here is that Jane is in the 35% tax bracket during her career because of her high annual income. She'll remain in that tax bracket due to her income only rising, not falling, and any pre-tax deductions she utilizes throughout her career are deducted at a 35% federal tax rate.

Let's assume now she is in retirement - her baseline income (salary) of $300k goes away. There may be some other income Jane has during retirement that creates some baseline income like:

  1. Dividends and interest from investment accounts

  2. Side work?

  3. Social security at 70?

I don’t want to make it seem like when she retires, all her income goes away. But realistically, unless she's stashed multiple millions in non-qualified accounts, has a large ownership in a company, mortgage-free rental properties, or other high income producing investments, her income is going to drop.

Let’s be generous and say her baseline income is $100k annually in retirement. This is a really impressive retirement income without including any retirement account distributions. But assuming everything else is equal, Jane’s taxable income would be the $100k - $13,850 standard deduction = $86,150.

Looking at the current single tax brackets, that puts her in the 22% tax bracket. If she needs more than her baseline income in retirement, she can take distributions from her deferred retirement accounts.

The 35% tax bracket (where Jane deferred this income) starts at an income of $231,250. This means Jane could take out $145,100 from her IRA ($231,250 minus her $86,150 of taxable income), and none of this money would be taxed as high as 35% - making her decision to defer a correct one.

Jane also has another almost $347k to take money out in the 35% tax bracket, which would have made this a break-even proposition. In other words, unless Jane’s income doubled in retirement to produce taxable income beyond the start of the 37% tax bracket of $578,135, she made the correct choice.

If Jane put the money in Roth during her working years, she would have to make an income of at least $231,250 in retirement BEFORE retirement distributions to be within the 35% tax bracket and “break even”. And more than $578,125 for this to have saved her 2% by prepaying tax at 35% and taking it out, tax free, at 37%.

Increasing Tax Rates

Of couse, this is a flawed example because it assumes everything stays the same, which is the point of this post. Many people are saying taxes can only go up. But what exactly does that mean?

I feel very strongly that the progressive system isn’t going anywhere. Therefore, when somebody says “tax rates are going up”, maybe this means each step is going to increase? If you look at the tax brackets above, let’s assume each tax bracket will increase 10%.

Continuing my example, Jane got a deduction at 35%. Any tax rate lower than that at time of distribution would be a positive outcome. With tax brackets increasing by 10%, the 24% tax bracket would become 34%, which is still below the deferral rate of 35%. And that bracket goes up to a gross income of $195,950 in today’s dollars ($182,100 taxable income after a $13,850 standard deduction). Not to mention, all this money wouldn’t be taxed at 34%, since her income has to go through the three other tax brackets first. Following the tax brackets and adding 10% to each, it would be:

  • $13,850 taxed at 0% (standard deduction, not included in taxable income)

  • The next $11,000 taxed at 20% (current 10% tax bracket + 10%)

  • The next $33,725 taxed at 22% (current 12% tax bracket + 10%)

  • The next $50,650 taxed at 32% (current 22% tax bracket + 10%)

  • The next $86,725 taxed at 34% (current 24% tax bracket + 10%)

This would result in an effective tax rate of 28.23% vs. getting the deduction at 35% - even with a 10 percentage point tax rate increase to all tax brackets.

Again, this progressive system makes things more than two sided. It is not higher vs. lower taxes. It is (currently) seven different tax brackets, creating a large array of outcomes. This decision is way more than answering the simple questions of:

  1. Will my income be higher or lower in retirement?

  2. Will taxes be higher or lower than they are today?

Either way, the early tax brackets (the current 10% - 24% brackets) may still remain lower than the current higher tax brackets if and when tax rates are increased, depending on the income discrepancy between your career and your retirement.

Final Thoughts

Maybe I’ve now created more complication to this tax planning game, but this is why tax planning is really important throughout your career, and having an understanding of how you’re taxed.

The rate at which you are taxed is more important that the dollars you pay in tax, which is why I focused solely on the rates throughout this blog. The example goes:

  1. Contribute $10k to a pretax retirement account, and save $3,500 in tax. That $10k grows 10x to $100k. When I take that $100k out, I am taxed at 35% or $35,000 and net $65,000.

  2. Contribute $6,500 to Roth retirement account, because I pre-paid $3,500 in tax. The Roth is invested the same and grows 10x to $65,000. I can now take out my $65,000 tax free.

In example 1, we ended up paying $35k in tax vs. example 2’s $3,500. But the net result is the same, because it comes down to tax rate, not dollars in tax paid. If tax rates are exactly the same at contribution and withdrawal, it doesn’t matter which you account you use (in regards to this math; there may be other variables). If rates went down at distribution, pre-tax wins. If rates go up during distribution, Roth wins.

The other item I want to throw out is that pre-tax gives you some flexibility. When you have money in there, you don’t have to take it out all at once. You can strategically plan around the tax brackets, and realize more income at lower income years, and continue to keep the money in the account during higher income years. This brings flexibility to the beholder of pre-tax accounts by having the ability to manage how much they take out.

When you put money in Roth, you’ve already made an irrevocable decision of pre-paying taxes.

Finally, what hasn’t been discussed in this blog is state tax rates because every state is different, but this may also influence these numbers depending on if your state allows retirement deductions, has a similar progressive tax system, if you’ll move to a lower taxed state during retirement, etc.

This may sound like I prefer pre-tax, but this isn’t true. I just see a lot of “advice” to do all Roth due to tax rates rising in the future, which I don’t think is a valid argument.

Everybody’s situation, financial goals, and future tax opinions are different and this is just a piece of the decision.


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