Roth or Traditional Contributions: Which is Best for High-Income Earners?
Understanding Roth and Traditional Contributions
Today, we're diving into a topic that's often a point of confusion for many high-income earners: Roth versus traditional contributions. This decision can significantly impact your financial future, so it's crucial to understand the basics and the factors that should guide your choice. Let's start with the basics. Traditional contributions allow you to save on taxes in the current tax year. You put money into your retirement account pre-tax, which means you don't pay income tax on that money until you withdraw it in the future. On the flip side, Roth contributions are made after-tax. While you don't get an immediate tax break, the money grows tax-free for the rest of your life. When you withdraw from a Roth account, you won't owe income tax at that time.
The Impact of Income Tax Brackets
Your income tax bracket plays a significant role in this decision. If you're in a higher income tax bracket now and expect to be in a lower bracket in the future, traditional contributions may be more beneficial. However, if you anticipate being in a higher tax bracket in the future, Roth contributions could be a better choice.
The Unknown Factor: Future Income Tax Rates
It's also important to consider the potential increase in tax rates. While it's reasonable to speculate that tax rates may increase, it's best not to base your decision solely on this speculation.
The Mega Backdoor 401(k)
In a previous episode, we discussed the concept of the mega backdoor 401(k). This strategy allows you to maximize your contributions beyond the regular limits. If your tax brackets are the same now and in the future, it doesn't matter whether you choose Roth or traditional. The decision is an arbitrage question, based on whether you expect to be in a higher tax bracket now or in the future.
Wrapping Up
The decision between Roth and traditional contributions is a personal one, depending on your current and future income tax situation. I hope this episode has shed some light on the topic and will help guide your decision.
