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It actually doesn’t matter whether you compound pre or post tax, only thing that matters is whether your tax rate changes between now and retirement.

by xyzzyz 5y ago

otterley 5y ago
This math doesn't seem right. Deferring taxes gives you significantly more money to invest early and take advantage of compounding. Additionally, the model is that you pay off your home mortgage before retirement, which means you need to withdraw a lot less during retirement years, which lowers your overall tax rate as well.
- davidgay 5y ago
  > This math doesn't seem right. Deferring taxes gives you significantly more money to invest early and take advantage of compounding. No, the grandparent is correct. The tax rates and compounding are both multiplicative, so associativity leads to the consultation that only the tax rate at saving-time and retirement-time matters
- swimfar 5y ago
  It does sound suspicious, but it works out. Let's say you have $100k to invest, have a 30% tax rate, and your investment will give you a 2x return by the time you're ready to withdraw. Pre-tax investment: Invest $100k and it becomes $200k. You pay $60k in taxes and end up with $140k. Post-tax investment: You pay $30k in taxes and invest $70k. That $70k becomes $140k.
  - deleted 5y ago
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  - ac29 5y ago
    That falls apart if you are maxing the contribution though. A maximum contribution to a Roth IRA is going to be more valuable than a maximum contribution to a Traditional IRA. Yes, technically with the latter you will have more money left to invest in a separate taxable account, but not being able to defer taxes will drag on the investment return.
deleted 5y ago
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deleted 5y ago
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swimfar 5y ago
Not sure why people don't like this comment. It's correct. Whether you pay taxes on your income and then invest it, or invest it and then pay taxes when you take it all out the result is the same (assuming your tax bracket doesn't change.) If you expect to be in a lower tax bracket when you take the money out, then invest pre-tax money. If you expect it to be in a higher tax bracket, invest money after you pay taxes on it. Obviously this is a very simple way of looking at it. But I think it's a good way to get a general understanding of the different options. Post-tax investments can be good if you need to pull out a big lump of money while retired.
- derekp7 5y ago
  From my understanding, this is not correct. 401K contributions reduce your marginal tax rate. So if you make 100k and contribute 15k, you save about 24% in taxes. Then when you withdraw 100k a year during retirement, you pay only 18% in taxes. On top of that, since you are only feeling a 11k reduction in your paycheck per year, but investing 15k, you end up with that much higher growth overall starting with a higher base. The only time expected retirement withdraw rate (treated as income at that time) matters is when choosing between Roth and traditional 401k / IRAs. In that case, with Roth you are contributing a lower amount initially (11k reduction in pay = 11k invested, instead of 15k invested), however the interest grows tax free. So if you are investing enough that the interest gives you a huge amount of money during retirement such that your annual retirement income (using 4% rule) gives you much higher pay, you would be better with Roth. But in no case are you better without any tax advantaged account.
  - creatornator 5y ago
    I think this is what they were saying--pre-tax refers to traditional, post-tax to roth. Only traditional ira/401k reduces the marginal tax rate. So the decision to go for traditional or roth depends on how you expect your tax bracket to change.
- toomuchtodo 5y ago
  https://www.gocurrycracker.com/roth-sucks/ https://www.gocurrycracker.com/roth-sucks/
vmh1928 5y ago
In the US, with a Roth, if you start withdrawing at 59 1/2 the earnings are not taxed. If you contribute $100,000 (after tax) the Roth and it grows to $300,000 you can withdraw the $200,000 earning tax free. (you can also withdraw your contributions tax free of course.) So that matters. [edit: the account has to have been open for 5 or more years.]
- niij 5y ago
  But a $100k Roth contribution would have been a larger pre-tax contribution (maybe $130k or so). That would have compounded to be larger than $300k all things being equal. If you do the math on it as long as your tax rate is the same in retirement there's no difference between traditional vs Roth.

It actually doesn’t matter whether you compound pre or post tax, only thing that matters is whether your tax rate changes between now and retirement.

by xyzzyz 5y ago

It actually doesn’t matter whether you compound pre or post tax, only thing that matters is whether your tax rate changes between now and retirement.

otterley 5y ago

This math doesn't seem right. Deferring taxes gives you significantly more money to invest early and take advantage of compounding. Additionally, the model is that you pay off your home mortgage before retirement, which means you need to withdraw a lot less during retirement years, which lowers your overall tax rate as well.

davidgay 5y ago
> This math doesn't seem right. Deferring taxes gives you significantly more money to invest early and take advantage of compounding. No, the grandparent is correct. The tax rates and compounding are both multiplicative, so associativity leads to the consultation that only the tax rate at saving-time and retirement-time matters
swimfar 5y ago
It does sound suspicious, but it works out. Let's say you have $100k to invest, have a 30% tax rate, and your investment will give you a 2x return by the time you're ready to withdraw. Pre-tax investment: Invest $100k and it becomes $200k. You pay $60k in taxes and end up with $140k. Post-tax investment: You pay $30k in taxes and invest $70k. That $70k becomes $140k.
- deleted 5y ago
  [deleted]
- ac29 5y ago
  That falls apart if you are maxing the contribution though. A maximum contribution to a Roth IRA is going to be more valuable than a maximum contribution to a Traditional IRA. Yes, technically with the latter you will have more money left to invest in a separate taxable account, but not being able to defer taxes will drag on the investment return.

deleted 5y ago

[deleted]

deleted 5y ago

[deleted]

swimfar 5y ago

Not sure why people don't like this comment. It's correct. Whether you pay taxes on your income and then invest it, or invest it and then pay taxes when you take it all out the result is the same (assuming your tax bracket doesn't change.) If you expect to be in a lower tax bracket when you take the money out, then invest pre-tax money. If you expect it to be in a higher tax bracket, invest money after you pay taxes on it. Obviously this is a very simple way of looking at it. But I think it's a good way to get a general understanding of the different options. Post-tax investments can be good if you need to pull out a big lump of money while retired.

derekp7 5y ago
From my understanding, this is not correct. 401K contributions reduce your marginal tax rate. So if you make 100k and contribute 15k, you save about 24% in taxes. Then when you withdraw 100k a year during retirement, you pay only 18% in taxes. On top of that, since you are only feeling a 11k reduction in your paycheck per year, but investing 15k, you end up with that much higher growth overall starting with a higher base. The only time expected retirement withdraw rate (treated as income at that time) matters is when choosing between Roth and traditional 401k / IRAs. In that case, with Roth you are contributing a lower amount initially (11k reduction in pay = 11k invested, instead of 15k invested), however the interest grows tax free. So if you are investing enough that the interest gives you a huge amount of money during retirement such that your annual retirement income (using 4% rule) gives you much higher pay, you would be better with Roth. But in no case are you better without any tax advantaged account.
- creatornator 5y ago
  I think this is what they were saying--pre-tax refers to traditional, post-tax to roth. Only traditional ira/401k reduces the marginal tax rate. So the decision to go for traditional or roth depends on how you expect your tax bracket to change.
toomuchtodo 5y ago
https://www.gocurrycracker.com/roth-sucks/ https://www.gocurrycracker.com/roth-sucks/

vmh1928 5y ago

In the US, with a Roth, if you start withdrawing at 59 1/2 the earnings are not taxed. If you contribute $100,000 (after tax) the Roth and it grows to $300,000 you can withdraw the $200,000 earning tax free. (you can also withdraw your contributions tax free of course.) So that matters. [edit: the account has to have been open for 5 or more years.]

niij 5y ago
But a $100k Roth contribution would have been a larger pre-tax contribution (maybe $130k or so). That would have compounded to be larger than $300k all things being equal. If you do the math on it as long as your tax rate is the same in retirement there's no difference between traditional vs Roth.