WCI #359: Tax Deferred vs. Roth Contributions: A Deep Dive

This is the White Coat Investor Podcast where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high income professionals stop doing dumb things with their money since 2011.

This is White Coat Investor podcast number 359, tax deferred versus Roth contributions a deep dive. If you're looking to boost returns, lower taxes and build wealth, join the WCI Monthly Real Estate Opportunities list for tips and strategies to maximize your real estate returns. And for introductions to exclusive investment opportunities, expect educational emails that introduce you to syndicators, fund companies, online courses, and online real estate platforms. Go to whitecoatinvestor.com reopportunities to sign up today. You can do this and the White Coat Investor can help. All right, welcome back to the podcast. I hope you're having a great day today. You know, from our annual survey, I now know that most of you are commuting, but some of you are walking the dog or working out. And a few of you are just doing chores. And that's pretty much what you guys do when you listen to the podcast. So I hope you're having a good day doing that. If you had a crummy day, I hope it gets better from here. And if no one's told you thanks for what you do, let me be the first. Because your work is important. That's why you're in the White Coat Investor community, because you have a hard job. High income jobs almost always are hard jobs. They're hard because they take a lot of training. They're hard because there's a lot of risk. They're hard because there's often an icky aspect to them. But they all deserve appreciation. Because when we need somebody in this community, we really need them. Our quote of the day today comes from Benjamin Franklin, who said, beware of little expenses. A small leak will sink a great ship. All right, those of you out there who have not yet tried paid surveys as a side gig, you might want to check that out. A lot of White Coat investors have tried this and had success with it. You can go to whitecoatinvestor.com Physiciansurvey and find our recommended resources there. But you'd be surprised. Some docs are making tens of thousands of dollars doing these surveys. So check that out. You can do it in your, you know, in your, maybe not while you're driving commuting, but if your commute's on a train or something, then it's something you could probably even do while you're listening to this Podcast. All right, our guest today is somebody I was really impressed with. I was impressed with him when he submitted his talk for WC Icon. I was impressed with him when he gave his talk at WC Icon. I was impressed with him when he corrected something I did wrong in my talk at wcicon. And I was super impressed with him when we recorded this interview. So Chris Davin is going to be a force, I think, in the online personal finance community and I think you're going to enjoy this interview with him. We get into the nitty gritty in this interview, we're going to start really basic, but we're going to ramp it up pretty quickly and get to some pretty complex topics. But even if we lose you at some point in this podcast, hang on because we get down to the rules of thumb and the general things you need to know. Even if we lost you halfway through the podcast, stick around to the end and we will talk about those things. Our guest today on the White Coat Investor podcast is Chris Davin. Thanks, Chris, for being with us.

Thank you very much for having me.

All right, for those who are not aware, Chris was a speaker at the Physician Wellness and Financial Literacy Conference this year and did a fantastic job. I was super impressed with this talk and I said, man, we got to get that guy on the podcast and talk about this subject to a much larger audience. I mean, you had a pretty packed room in there, but even so, that was probably only 250 or 300 people and there'll be 30,000 plus listening to this podcast. So we gotta get this message out there a little bit more. But I'm not sure anybody out there listening actually knows who you are. So why don't we start? I mean, you're not a doctor, correct? Yet you've spoken at wcicon. How did you find yourself in the White Coat Investor community?

Yeah, well, thanks again for having me. Yeah, it's been a bit of a long journey to get into the personal finance community. So I'm an engineer by training and trade. So I work full time for a large engineering company. And I think around the mid 2010s was when I really became interested and serious about studying personal finance. I first became aware of White Coat Investor when I started to date the woman who's now my wife. She just started a residency. We met and I remember we went up to a ski trip up in Keystone, Colorado with a bunch of her residency classmates and I went up there. We rented a big house there for a ski for the weekend. And one of the guys who was there was talking about White Coat Investor and he's saying something about a backdoor Roth ira. And I had no idea what he was talking about, But I knew IRAs and I would contribute to my Roth IRA every year. And I thought, oh, this sounds interesting enough, I should go check it out. And I found your blog and read about the backdoor Roth ira. And by serendipity, that year was the first year my income had crossed the threshold to contribute directly to a Roth ira. So the timing worked out really well. And yeah, I read the message and again, I'm coming to this as an engineer and the methods that you put forth on the blog and really resonated with me. I think it was the very systematic approach reminded me a lot of the approach we use in my profession. You're not recommending anything crazy, but it's just sort of very straightforward and well thought out standard financial advice for people. And I believed in the message as well. I think that's another thing is that when I was younger I had had several interactions with financial professionals who were more of the salesman variety. And I had had some recommendations made to me that we're not going to be the best and in hindsight we're really just trying to get commissions. So the overall message of trying to connect people with the good guys in the financial industry, that also really resonated with me. And I'm still an engineer. I ended up marrying my wife and as our relationship got more serious, we got married and now we have a couple kids. I took it more seriously and now I'm at the point where I prepare all of our taxes and I'm active in the online financial community and yeah, it's kind of become a hobby. But your blog is the one that kind of got me started on it and it's one that I still read regularly whenever I have time, which these days isn't that often.

Yeah, pretty awesome. It's true what you say, though. I mean, this whole saving up for retirement thing is really an engineering problem, right? So an engineering approach is really the right approach to take to it. I'm not surprised that lots of engineers gravitate toward this process and get into it and love to dive into the spreadsheets and probably get too far into it most of the time, which is what we're going to try to do today. I think we're really going to go deep today.

I may be guilty of that. I'll let your readers be the judge.

Yeah, well, awesome. Well, we'll get there gradually. So hopefully we don't lose anybody at the beginning anyway, but we had something like 250 presentations this year for WC Icon that were submitted. And so it was a really competitive process. I mean, we took less than 50, and your presentation was chosen. So I'm curious why you decided to apply to be a speaker and how you chose your subject when you did apply.

Yeah, so why did I choose to apply in general? Well, you know, I'm a regular listener of your podcast, and, you know, you mentioned the conference quite a bit. And, you know, one of the things I enjoy in general, you know, if it's online or with friends and family, is helping people once you kind of learn it and understand it, at least for me, and I think this is also true for you. I think you've mentioned talking about it before. You have this feeling like, I gotta go share this with the world. This is so useful. And if only I had known this back when I was younger that I would have been able to make these better decisions. So I'm interested in it. I feel like at least this piece, I understand pretty well, and I want to share that message with people and help other people out. That's really a big part of the reason why I chose to apply. And then, of course, there's the fact that I've been a longtime reader of the blog and listener of the podcast, and it kind of got me started. So I have a little bit of a special relationship with WCI for that reason. And then the subject, it's one for just a variety of reasons that I've really studied quite a bit, I have tried to solve this problem. And I say problem, answer this question in my personal life, because in our family, we're kind of teetering right on the edge of whether Pre Tax or Roth is the best option. And I decided, well, let me see if I can take kind of a math approach to this and kind of start from first principles and work it out. And I came up with this method that I use, and there's a lot of rules of thumb out there, which are good, certainly, but it's a very difficult problem. I think that's one of the things I really like about it, and it's sort of almost fun for me to kind of tackle it, which is that it's very complicated. There's a lot of factors in it that have a lot of uncertainty. And, you know, your future investment performance, your future tax rates, you know, who can predict these things? But if you take this complex problem and you kind of break it down into a bunch of smaller pieces, then you can kind of solve those pieces, or at least a lot of them individually, and that's easier. And then the ones that you can't solve, you can take a reasonable guess at, like, hey, let's just assume tax rates are going to stay the same, and then you can, at the end, you can kind of pull it all back together, and then you get an answer. And then that's the way that I've done it in my own financial life. And then that general method of kind of breaking a complex problem down, solving it as all these little piecewise, solving it in pieces and then putting it back together, that's a very common method for dealing with these problems, and it's one that I thought would be a valuable subject for a talk.

Yeah, for sure. I mean, for those who haven't figured it out yet, we're talking about deciding whether you're going to do Roth contributions or tax deferred contributions. It's really a very similar decision to whether to do Roth conversions as well. But there aren't a lot of people on the planet who have thought about this more deeply than I have. And one of those is Chris. And so I was very impressed sitting there in his presentation. I'm like, wow, he's put a lot of time into this, spent a lot of time on assumptions, understands what's actually going on, and I think has made a few breakthroughs in it that ought to be shared with the world, quite honestly. And so this is the best way I know how to do that.

Well, thank you.

Now, we're going to get into the weeds today. There's no doubt about it, right? We're here on the WCI podcast to start with, and my guest is an engineer. We're going into the weeds, there's no doubt about it. But before we do so, I want to make sure we cover all the basics, too. So, Chris, can you start by just explaining the difference between a traditional or tax deferred retirement account and a Roth or tax free retirement account?

Sure, yeah. So the two terms, I think are interchangeable. Either traditional tax deferred or pre tax. Those are all three terms for basically the same thing, which is that when you earn money and you have to have earned income when you earn money, you can avoid paying tax on it in the year that you earn it. And instead of paying tax on it and then having it come out, like into your checking account, it can go into a retirement account where it will then grow tax deferred for decades potentially. And Then when you are ready to retire, you can withdraw that money and then when it comes out, it counts as taxable income. So this is the reason it's called traditional is because this was the original type of retirement account. This was, you know, the 401k. And there's a lot of benefits to it. You know, most people most of the time are going to have a higher tax rate when they're working than when they're retired. So this is sort of the standard or default choice. And it's the one that's been around the longest. The opposite of that is the Roth account. And sometimes people do call that tax free. So the contributions that you make go in as after tax dollars. So even though you contribute it, you're still taxed on that money and you have to pay tax on your tax return. But once it goes into a Roth account, then it will grow tax free. And then when you withdraw, as long as you meet the eligibility requirements, like you know, being over 59 and a half and I think having an account for five years, there's, there's several five year rules, but that's one of them. Then when you withdraw money, it's tax free. So it's really this choice between do I want to pay taxes now and that would be the Roth option or do I want to wait and pay taxes later? And that's the traditional option. And most flavors of retirement accounts now have a Roth option. So originally it was the Roth IRA. Then I looked it up, the Roth 401K started in 2006. And then we've got, there's a Roth versions of 403BS, 457S. Now with the Secure Act 2.0, there's a Roth SEP IRA. So a lot of different retirement accounts now have a Roth option. So people are going to have, most people are going to have a choice of which tax structure that they want to choose.

Yeah, and I think it's important too at this point to point out that both of these are excellent things, right? Comparing these to a regular non qualified taxable brokerage account, they're both better, right? Because your money grows without you having to pay taxes. As it grows, you're not paying taxes every time your investment pays a dividend. You're not paying taxes every time you buy and sell something inside the account. Plus in, you know, in just about every state, these retirement accounts get an incredible amount of asset protection. I mean, you can declare bankruptcy and still get to keep what's in your retirement accounts. Plus there's all These great estate planning benefits, they can be stretched by your heirs for up to 10 years. You can just designate beneficiaries and avoid probate. There's all these great reasons to use retirement accounts. So don't let the fear of not being able to choose the right one to use keep you from using one of them. Because they're both almost always going to be better than using just a regular taxable account. So keep that in mind as we're talking about these.

Yeah, I completely agree.

The next basic we got to cover before we get into the weeds here is we got to talk about a Roth conversion. Can you explain what a Roth conversion is? How one might do one and why might, why one might want to do one?

Sure.

Yeah.

So a Roth conversion is whenever you move money from a pre tax account to a Roth account and generally speaking, that amount that you move becomes taxable income in that year. So I think it's worth thinking about this in terms of IRAs and then workplace plans because the rules of how these work, you know, kind of the finer points are different from the two. So if you have pre tax money in an ira, you can move it into a Roth IRA at any time. There's no restrictions on income, there's no restrictions that the plan was going to put on you. So you basically have an unlimited ability to convert to Roth for a workplace plan. It can get a little bit more complicated. So let's say you have $100,000 in a pre tax 401 and if you're continuing to work, then there is only an option to convert that to Roth if the plan allows it. So usually the two choices are you can either do an in plan Roth rollover, which is you move it within the workplace plan from the pre tax account to the Roth account and then they send you a 1099, or you could do a rolling it out a rollover into a Roth IRA that's outside of the plan. So those are usually the two choices. But if you're working, a workplace plan does not have to allow either of those two. So it can get a little more complicated if you want to do Roth conversions and you're working and all of your pre tax money is within a workplace plan like a 401k. Now that said, you do have some options when you separate from that employer. And that's usually a more common time when people want to do Roth conversions is when they're leaving a job. You know, if you're, if you're between jobs, you have a period of unemployment in between, your income is going to be lower that year. That may be a time to do Roth conversions and then you can take some of that money out. But generally speaking, that's what a Roth conversion is. How do you do one? Well, the short answer is you contact the firm that's holding the money and you can ask them. And most firms now, either whether they're IRAs or 401ks, they usually have at most just like a form you have to fill out and send it in. A lot of times you can just do it online. They have an online form. One caution that I would share is that if you're going to do Roth conversions toward the end of the year, which is that's a really common time for people to do them, you know, you have a really good idea of kind of what your taxable income is going to be and you know, you've gotten the tax deferred growth for as long as possible. Just be careful about doing it in the last couple of weeks of the year because a lot of brokerages are inundated with withdrawal requests. And there have been stories of people trying to put in a conversion request on 29 December and it goes through the next tax year. So you want to give it at least a week or two and then also add in if you have to sell some investments, if you've got money in mutual funds, you want to leave a couple of days to be able to put the sell in, to have the order go through, get the cash in the account and then to convert the cash. So yeah, that's, that's generally what it is. And how to do one. So why would you want to do this? Well, a Roth conversion is a really powerful tool that lets you basically take advantage of a low tax rate any year that you might have one as long as you have pre tax money. So, you know, again, this could be if you are switching jobs and you have unemployment or if you're taking time off for, you know, for any reason, or, you know, if you're even, you know, moving to a lower tax state and you decide that the tax rates are favorable and you want to do some conversions to avoid the state taxes that you might pay later. There's a thousand reasons why you might want to do that. But you know, Roth conversions are a way to take advantage of a low tax rate whenever you have one. And you know, if you sort of think about the big picture, right, we have a progressive tax system in this country. So you know, there are exceptions to this, but generally Speaking as your income goes up, your tax rate goes up. So the Roth conversion lets you kind of balance that out over your whole lifetime. You know, between the time you're working, anytime you have off early retirement, later retirement, you can use Roth conversions to kind of fill up lower brackets in any of those years that you might have them. And usually the typical times that people will convert are, as I mentioned, if you have a low income year, that's a good time to check to see if it's worth doing. A caution on that though is that low income does not always equal low tax rates. There are a bunch of tax credits that can apply if you're, you know, if your income drops, earned income tax credit, savers credit, things like that. So, you know, you want to actually check and make sure your low income is giving you a low tax rate where the Roth conversion is going to be favorable. But that's a, that's a common thing that people do throughout their career to sort of take advantage of any of those lower income low tax years. And then the other time is in early retirement. So, you know, the general standard advice, and it's which one that I subscribe to is, you know, if you're, unless you have health issues or if there's other uncommon situations, you probably want to take Social Security at 70. So if you retire at, let's say 65 and you're taking Social Security at 70, and you don't need that full withdrawal to live on to fill up all your lower brackets, you can do some Roth conversions in early retirement to fill up the lower brackets that are available to you. And then that will reduce your RMDs later. And then if you're able to convert at a similar rate or a lower rate than what you expect to pay in the future, then you're going to come out ahead by doing that.

And let's define RMDs as well. RMDs are required minimum distributions. This is the money you're required to take out of pre tax accounts starting at, for most people listening to this, starting at age 75. So if you don't have money in pre tax accounts, you don't have to take RMDs out of them. So that's another advantage of Roth conversions. I think it's important to distinguish this too because a lot of people get confused between a Roth conversion and a backdoor Roth IRA and a mega backdoor Roth ira. Now, one of the steps in the backdoor Roth IRA process and the mega backdoor Roth IRA process is a Roth conversion. But the first step in each of those is making contributions that you don't get a deduction for. And so the cool thing about the conversion in those two processes is, is that you get a tax free conversion, it doesn't cost you any taxes when you do the conversion step. Most of the time when you're doing a Roth conversion, you're converting pre tax money, money that you are going to have to pay taxes on when you do the conversion. But in those two processes, the backdoor Roth ira, which you do in an ira, and the mega backdoor Roth ira, which is probably misnamed because you do it usually in a 401 or a 403, you're not converting that pre tax money, you're converting after tax money. And there's no tax cost to that. So it's important to distinguish those things. I have a lot of people email me and talk about backdooring things, but what they really mean is doing a Roth conversion. So these are all separate terms. And part of financial literacy is learning the terminology and being precise when you use it. So hopefully we can help you with that today. All right, I think we need to talk about probably the most important thing before we really get into the nitty gritty here is, is tax rates. Because that's what really matters. One of the biggest misconceptions out there is that when you're deciding to do a Roth or a tax deferred contribution, or when you're deciding whether to do a Roth conversion, is that somehow the amount of tax that you pay matters. People say you should pay on the seed and not on the full grown tree or not on the harvest. But in reality what really matters is, is the tax rate at the time of contribution compared to the tax rate at the time of withdrawal. How can we help people to better conceptualize this? Because this is probably the biggest misconception out there about this.

Yeah, I'd agree with that. So the problem with just looking at dollars is that it ignores the time value of money. So if you pay $10,000 in tax a day versus paying it 40 years from now when you're retired, in your 80s or whatnot, those are very different expenses. One of those is much better than the other for you. So yeah, it is a mistake to think about it in terms of just dollars. I would say in the big picture, what we really want to maximize is our after tax income and the after tax value of our accounts when we're retired. That's what essentially you're going to live off. Of, and we try to maximize that because that's going to give us the biggest quality of life when we're in retirement. So the way to do that is by looking at the tax rate. It doesn't actually matter really whether you pay a fixed percent today or whether you're retired or anywhere in between. The timing of it. If it's just a fixed percent tax that you pay, doesn't matter. The way to get the most money when you're retired is to find the time between now and then when you're retired, where you're going to pay that lowest rate. And that might be today. If it's a very low income year for you, you can make a Roth contribution today, pay the taxes now and then, never again. Or maybe you do pre tax now and then you're expecting to have lower income years in the future where you might be able to do a Roth conversion, pay the taxes then. Or maybe the best time is to just wait and pay the taxes when you're retired, if that's going to be your lowest rate. So you want to, as best as you can, try to think about what your whole lifetime tax situation is going to be and then choose the time that you think is going to be the lowest rate and that will get you the most income when you're retired.

All right. As a general rule, people are tax illiterate, right? They don't understand how taxes work. They don't understand the tax code. It is complicated, right? I mean, it's how many inches of pages in a book is the tax code. And nobody can read the tax code because it's written in accountants speak. But people need to understand their marginal tax rate. And it's not just your tax bracket, is it? Your marginal tax rate is more than your tax bracket. Can you explain why that is?

Sure, yeah. So, well, there's a couple terms we kind of got a piece apart there. So one of which is marginal, which means marginal in economic speak means just a small amount of money or a small change. So for instance, if you earn $100,000 a year, your marginal tax rate is not the total tax you pay on that $100,000. That's going to be like an average tax rate or something. And maybe that's useful for budget planning or something. But when we're making these decisions, we really care about the tax rate on a change of income because that's what we're talking about. If we, you know, if you have $100,000 and you contribute 10,000 to a retirement account, we care about the tax rate that you pay on that 10,000 or, you know, whatever the number is. So marginal means on a small amount of income. But the tax rate is a composite of all kinds of effects that come on, as you say, from this, you know, very complicated tax code. So, you know, we think about it in terms of tax brackets, and some people, their tax bracket is their marginal tax rate. But there's a lot of other reasons why someone's actual tax rate may be different from their tax bracket. I can think of some examples, such as the phase out of the child tax credit. So the child tax credit, I believe it's $2,000 per dependent child you have. And then there is an income component to that. So as your income increases above a threshold, the government starts to take back some of that credit and the loss of that credit is really equivalent to paying a higher rate on your income. And there can be other examples too. We'll talk about IRMA in a little bit. But there's phase ins of different kinds of income, there's phase outs of credits, there's all these complicated effects, and there's probably a list of at least a dozen of them that are relatively common that will affect people's tax rate. So money is fungible. So if you're thinking about your total tax rate and everything that contributes to that, it doesn't really matter whether you're losing a dollar of credit or you're paying a dollar on your tax bracket scale, those are really the same thing. So this is really something that you need to measure with software. It's not something that you can just kind of sketch out by hand. You know, for instance, if you do your Talk taxes and TurboTax, you can go in and let's say increase your income by $10,000 and then 20 and 30, and you can write down those numbers and you can see kind of what the total impact of the taxes that you owe is. And most likely it's not going to be just your tax bracket.

Yeah, particularly in those middle tax brackets where so many of these phaseouts live lower to middle ones. I mean, once you're kind of in the top tax bracket, there aren't very many phase outs that affect you. But if you're in the middle ones and you're in the lower ones, there are lots of these phase outs of credits and deductions and so on and so forth that can really have quite an effect making your tax rate very different from what your tax bracket might be. But basically, yeah, it's your rate at the margin. That's the way to think about that.

Yeah.

Okay. Everybody thinks tax rates are going up. You know, they have to go up. The government's spending so much money running these deficits. We have huge debt. Tax rates are going to go up. You know, so they say, oh, I've got to do Roth, because rates are going to be higher in the future. Can you explain why an increase in the general tax rates might not matter as much as people think it does when it comes to these sorts of decisions?

Yeah, well, this is one of the very hard components of this question, which is, you know, what are tax rates going to be in the future? Obviously that matters a lot. I think it's fair to say that most likely if there are changes in the tax code, there are still going to be these sort of lower brackets and lower tax rates that you can fill up with relatively small amount of income. You know, it's possible the government could eliminate that. I don't think that's likely at all. I mean, I guess if we go to like a complete flat tax with no, no deduction, no standard deduction at all, that could be the case, but I think that's pretty unlikely. So I think is more likely to happen is that the rates on some of the brackets will go up or down, which is really what we saw in the Tax Cuts and Jobs act that was, was passed in 2017. It became effective in 2018 where for instance, the top tax bracket went down from 39.6 to 37. But as long as there are going to be these lower brackets that you can fill up with pre tax withdrawals, there will still be an advantage to saving pre tax now and having enough so that when you are withdrawing your reasonable percentage of that, I usually say 4%. That's sort of a standard withdrawal rate. So if you're carrying a pre tax balance into retirement and 4% of that is enough to kind of fill up those lower brackets, then you've still gotten an advantage from saving pre tax now even if those rates go up. Now I will caveat that though, which is that you have to think of it in terms of what your pre tax balance is likely to be. So for instance, in my talk I gave an example of a couple that in their forties they had already saved like $1.5 million of pre tax money. Now that one and a half million is going to grow between your forties and your sixties when you retire. Assume this couple is going to retire in their 60s and that was going to grow enough at reasonable rate of return where that was already going to fill up those low tax brackets. So if you're already sort of ahead of the curve on your pre tax savings, any additional savings that you would do is going to come in on top of the savings that you already have, combined with the growth that you expect to get on that between now and whenever you are going to withdraw it. So it is very likely that there will still be lower rate tax brackets in the future. But whether those are going to be available to you or whether your plan has already filled those up and then now you're considering putting money that's going to stack on top of those, that depends on your individual situation. And that's something that you really have to sort of run the numbers to figure out.

Yeah, there's other ways to fill up those brackets too. Maybe you have a bunch of rental income from some real estate empire you've built, or maybe you have a pension coming and Social Security can start filling up some of those as well. So lots of ways to fill those up.

That's right.

Yeah. Okay. At this point, I think we've kind of run the gamut of the basic topics here, and we're now moving into intermediate range. This stuff's starting to get a little bit more complicated. So those of you that are just barely hanging on, do your best here to hang on to the rest of this discussion, but know that we're about to step it up a little bit. Talk about some things that are a little bit more complicated here. Now, in most discussions of Roth versus Tax deferred, including those I've done over the years, a number of blog posts we've talked about on this podcast before, I've talked about it in presentations, but people focus on the various qualitative factors that should make you lean one way or the other. This makes it more likely that you want to do Roth, or this makes it more likely that you want to do pre tax. And what I loved about your WCE icon talk is that you went one step beyond that. You actually tried to quantify all of this. But before we get into quantifying it all, which is when we move to the advanced portion of this podcast, I think let's talk about those factors. And there's probably a dozen or more of them, but can we talk about some of those and why they would make someone lean one way or the other toward Roth or toward tax deferred contributions?

Yeah, sure, we can talk about a few of those. So just by virtue of the way the tax code is written There are some asymmetries in whether you should go pre tax or Roth. Certain accounts have certain sort of advantages that the other one doesn't. And you know, just to give an example, pre tax money can be converted to Roth at a later time, at an opportunistic time. And there's no way to go backwards on that. Once you convert to Roth, that's it. There's no way to take money from Roth, move it into pre tax and get a deduction. That's not allowed. So if the future is uncertain, and it always is to some degree, then having a little bit of extra money in pre tax I think is a good idea because it will give you some dry powder that you can use to capitalize on any opportunities to do Roth conversions at a lower rate in the future. And it could even be, you know, half a year, you know, in between jobs or a move or things like that where you might have that advantage. And that's not an advantage for Roth. So, you know, that would be one example. Another one would be rmd, as we mentioned, require minimum distributions. Roth accounts do not have RMDs, and pre tax accounts do. So, you know, if you're in the situation where you're expecting to have really large RMD is more than you would spend and what you expect to do is to reinvest some of that RMD and in a taxable account, where then it's going to have that tax drag and capital gains tax and tax on dividends while it grows for potentially decades in your retirement, then I think it's good to lean a little bit more toward Roth. Another thing is that if you're doing estate planning, there can be some significant estate planning benefits to one or the other. I don't think there's really a clear winner for estate planning. It just depends on your situation. If you're giving a lot of money to charity, pre tax money is great because you avoid the taxes and the charity does too. If you're leaving money to low income or lower tax rate heirs, then doing pre tax is good. If you're leaving money to higher tax rate heirs, Roth is good. And there can be other special situations where you would want to do one or the other. Like if you're leaving money into trusts or if you have someone who has a need to keep their taxable income down because they're getting benefits of some kind that are income dependent, like a.

Disabled kid trying to qualify for Medicaid or who has an age stable account, that sort of a thing.

Yeah, yeah. Exactly right, yeah. Or if you have somebody on some sort of assistance that would be phased out by income, that would be something that you'd want to do. Early retirement, I think is another one worth talking about. So if you're going to retire early, the tax code favors pre tax savings because when you take money out of pre tax early, you pay taxes on it, but you don't pay any penalties. If you try to do that with Roth, then the tax code will still tax you on the growth of that that you take out when you're younger than age 59 and a half. So that's sort of a disadvantage. And I think, you know, especially in early retirement, there are other reasons why pre tax is probably the best. So, you know, usually someone who's saving for an early retirement, they probably have, you know, relatively speaking, a higher income when they're working and a lower income when they're retired just because they have to stretch that savings for more decades. So those things all tend to favor pre tax. So pre tax is the standard suggestion if you're looking for an early retirement. And then I think another one that is worth mentioning is this contributing the maximum effect. So Roth has an advantage. That's because the dollars that you contribute into a Roth account are actually worth more than in a pre tax account. So for instance, the standard elective deferral limit if you're under age 50 in 2024 is $23,000. So if you're contributing to Roth, you get to put effectively more of your own money into that account because you get to keep 100% of those dollars. Whereas if you contribute 23,000 pre tax, the government owns a piece of those, at some point they're going to come and take it in the form of tax when you withdraw it. So you're able to get more money into the retirement account, you're able to get more tax protected growth for longer and over a longer period of time that can actually make a difference in the value of your account. So that would be a reason to contribute or to lean toward Roth if you're contributing the maximum.

Yeah. Another difference in the estate planning you mentioned is that you're allowed to stretch an IRA over 10 years, but it sure is a whole lot better to be able to not have to spread out the tax withdrawals from that from an inherited IRA over multiple years. Right. You can just take out the minimum where you're required to take out each of the first nine years and then take it all out in the 10th year if it's Roth, that's almost always going to be the right way to do it, unless you need the money. But that's not necessarily the right way to do it if you have pre tax money in that inherited ira. And so people might want to spread that out over more years and thus they end up with fewer years of tax protected growth in that stretch IRA period. So there's just all kinds of these. Another one's, you alluded to it earlier. It's what I call the super saver effect. You know, if you're saving so much money that you're going to be in the same bracket in retirement or an even higher bracket, you know, that's obviously going to make you want to lean toward Roth. You know, these people that I meet them all the time, they've got a 45%, you know, savings rate and they're planning to work until they're 70. You know, these are not people that pre tax is going to favor. You know, you just, you've, you've already filled up all those brackets many years ago essentially, and you want to now favor Roth accounts. I've even seen something when I did my asset protection book and looked at the asset protection laws for all 50 states. There's at least one state out there that protects IRAs and bankruptcy and doesn't protect Roth IRAs in bankruptcy. There's all these little tiny things that can make you lean one way or lean another. Some of them are bigger than others and it can sometimes be difficult to quantify them. But I think one of those that you mentioned is a really big one that we really need to hone in on and focus on. And that's the idea. And it's really kind of unfair, actually, that the contribution limits are the same for a Roth 401 as they are for a tax deferred 401. That's really not fair. You're putting more money into a Roth 401 than you are into a tax deferred 401 just because it's more after tax money. And that's really the only money that matters. And so you have to invest. Now if you're going to invest more to make these equal, if you've maxed them out, it's going to have to go in that taxable account where it won't grow as quickly because it's being taxed as it grows, it has that tax drag on it as you're growing. And I don't think that, I think that can be, you really need to be aware of that because that can be a fairly big deal, can't it?

Yeah. So one way to kind of analyze that is to look at what your breakeven future tax rate would have to be to make a traditional and a Roth account equal.

Now, this is assuming you're maxing them out. Of course, this isn't putting $10,000 of either one into a 401. This is maxing them out. So you have to put additional savings into a taxable account to make them equal.

That's right, yeah. And the amount that you put in the taxable account to equalize them is just the tax that you save by making that pre tax contribution, because that's the difference. And then you can calculate the value of those accounts as they go forward. And you have to account for the tax drag and the change in basis of the taxable account. But there are formulas where you can do that and then you can look at the future value and then you can find that break even point. So the kind of the simple case that we've been talking about, if you're not contributing the maximum is if you can contribute, let's say at 32% now, your break even in the future is 32%. So if you, if you're going to pay less than 32% in the future, you do pre tax. If you're going to do, you know, pay more than you do Roth. But that number, if you're contributing the maximum, it creeps down over time. And I looked at in the talk, I presented a few cases, but I think for the like, for instance, for the 37% bracket, after 10 years that break even drops down to like 32%. And then at 20 years it's 29, and then at 30 years it's 27 and at 40 years it's 25. So you know, if you're in the 37% bracket now and let's say you expect to be in, you know, 40 years later, you're going to be in the, you know, the 32% bracket. And if you didn't include this effect, you'd think that contributing pre tax was the right way to go. But that's actually not true because you're going to lose more in the dividend tax and the capital gains of the taxable money than you're going to save on the tax rate arbitrage. So only if you would be in the 24% or lower when you're retired should you then do pre tax. But if you're going to be anywhere above, again, this is for 40 years. So this is kind of a long time horizon. But if you're predicting you're going to be any higher than 25%, you should still do Roth even if you're at 37% today.

All right. Well, we have now left Roth versus tax deferred 101. We have now left Roth versus tax deferred 201. We've now moved to the graduate level here and we're going to start talking about quantifying some of these factors here. You know, one of the recommendations in your talk that I thought was really interesting was for how to deal with irmaa and for those who aren't aware of what IRMAA is, IRMAA is basically an additional fee you have to pay for your Medicare. It stands for Income Related Monthly Adjustment Amount I RMAA irmaa. Basically, if you have high income, you gotta pay more for Medicare in retirement. It's not all that dissimilar from the subsidy that you get when you buy an Obamacare health insurance policy on the exchange. That's kind of a progressive price structure that happens before age 65. And IRMAA is a progressive pricing structure to health care insurance, for lack of a better word, that happens after 65. But you gave a really interesting recommendation, I thought, which I had never heard before, and I think you came up with it on your own. It sounds right to me. But you talked about how to deal with IRMAA both in the mid to long range as well as in the short term range. Can you talk a little bit about that?

Yeah. So let me just talk a little bit about what IRMAA is first, just to make sure that it's clear. So as you mentioned, it's an extra premium that you pay on your Medicare premium starting at age 65. But there's some quirks about it that make it sort of a little difficult to sort of plan for. I will say it's technically not a tax. You know, this is not something that appears on your form 1040. It doesn't go on your tax return, but it is strongly dependent on income and it sort of behaves like a tax. So again, sort of going back to, you know, the concept we talked about earlier of your marginal tax rate, this is an example of something that is not on your tax return that I would actually include in your sort of overall marginal tax rate because it behaves exactly the same way. And again, a dollar in IRMAA premiums that you would pay is no different than a dollar of extra tax on your 1040 or a dollar of a lost tax credit. So the way IRMAA works, there's a two year delay. So the IRMAA that you would pay if you're over 65 in 2024 is a function of your 2022 modified adjusted gross income. So this is your income two years earlier and this is because it's your adjusted gross income. This is before any of your like below the line deduction. This is before your schedule A deduction, your standard deduction. You know, if you're still earning and running a business, your 199A deduction. This is basically your adjusted gross income. And the first tier starts at for single filers it's $103,000 and for married filers it's $206,000. It's double that. And then once you cross that threshold, you're going to pay about an extra thousand dollars per person over the year in Medicare premium. And then there are additional tiers. There's one at 129, 161 and 193k for single and then double those 258, 322 and 386 for married joint filers. And then of course if you're married joint, then you're going to pay double that because you just have two people. So those are going to increase. And this is, I think, something that is a little bit misunderstood and that's why I wanted to mention it in the talk. I've seen misunderstandings go sort of both ways for this. Some people just choose to ignore it, which I don't think is the right thing to do because they say, well, you know, if you're between any of these tiers, then you know you're effectively your marginal tax rate is zero when you're moving in between any of those tiers. But when you cross into the next one, you pay the full price for that new tier. So you know, technically speaking, if you're making kind of small changes in income, it's not affecting your tax rate, but over a wider range of income it does affect it. And you know, the what I presented in the talk is it's about 5%. You know, if you look at the four tiers there that are kind of between this either one and $200,000 income for a single or two to $400,000 married, the first one is about $1,000 and then it's about 1,500 for the next three. So that's about $5,500 that you pay over a range of income of about $100,000. So that works out to be just about 5%. So my suggestion, what I suggested in the talk and what I've suggested for other people is that if you expect to be in this IRMAA range and probably a lot of your listeners are going to be, this was sort of a very common range for like a high income professional what their taxable income is going to be when they're retired, then you should include the fact that you're going to be sort of moving through these tiers and paying this average sort of tax rate of about 5%. Now I have also seen misunderstandings go the other way and people say, oh my goodness, this is something I should absolutely avoid. And then I'm just going to do tons of Roth conversions in my account and get my pre tax account so I don't have to deal with them. I don't think that's the right answer either. If you're doing roth conversions at 30, 40, 50%, that's probably a lot more of an overall tax rate than you're going to pay just by paying some Irma. But yeah, that was, that was a standard recommendation. Now if you go above that range, there is actually one more ermit here and it's really small. It's about $500 per person. That's for single, it's $500,000 per year of income and it's $750,000 for married joint filers. But that one I think is kind of worth ignoring. I mean, it's so high up and the price is much smaller than the other tier. So that one you can sort of ignore. But this most dense range of income is between 1 and $200,000 single and 2 to $400,000 married. I think it's worth treating it like a tax and adding in the appropriate tax rate, which represents sort of the average tax cost of this, which is about 5%. Now if you're doing sort of very short range planning, for instance, if you're already retired and you're trying to decide how much to Roth convert, then you can do a little more tactical planning and say, okay, well I want to come in just under one of these spikes and there's some difficulty in that too because there's this two year delay. So you don't know when you're doing a Roth conversion this year what the thresholds are going to be because the government hasn't come up with the inflation indexes for the next two years yet. If you want to wait until very the end of the year, I think they're usually published for the next year around October or November. So if you're doing a Roth conversion in December, you can have half the data that you would want, but you still don't know what the inflation adjustments are going to be for the second year. So you have to take a guess at that and then you can use that. But usually if you're trying to tune your income that way and you're doing it in this kind of the two or three year time range, then you can try to come in just under one of those tiers. But for long range planning, it's just, there's not enough, or I should say, there's too much uncertainty in all the variables. So you just take your best guess, assume you're going to be in that range and add 5% if you are. And that's the way that I do it.

Yeah. The tricky part about it is you can't use tax software for this. You've got to do this manually because it's not a tax. And so you first gotta use the tax software to figure out what your marginal tax rate is, and then you've gotta add this to it. You've gotta have this manual process on top of an automatic one. So it's particularly challenging there.

There is a piece of tax software that is available for free that will include irmaa, and if you go on Bogleheads, it's called the Personal Finance Toolbox. This is a, it's basically a huge spreadsheet that somebody over on the Mr. Money Mustache forums came up with. And it will fold in the effect of irmaa. So if you put in that you're, you know, you put in your age, and if your age is within the range where you're going to be paying Medicare premiums, it will tack that on and it will fold that into your future tax rate. So that can be a nice shortcut for people who are, who are trying to see if this is going to be an issue for them.

Very cool. Thank you for sharing that. All right. The next part of this, I think, does not lend itself very well to a podcast. You know, this, I think, would be much easier for you if you were able to show people, you know, slides in a presentation, if this were a blog post sort of format or a forum format. But we're going to do the best we can with this particular format. You know, everybody loves podcasts because you can listen to them while you're working out or while you're, you know, on your way to work or whatever. But it does have some limitations and a complicated discussion like this I think is one of the limitations. But as best you can, can you explain to us your method to predict your future marginal tax rate?

Yeah. So in a nutshell, what I suggest to people is to prepare a mock tax return for what you expect your tax return to look like when you're retired as best as you can. You know, again, I don't suggest making assumptions about huge changes in tax law. You know, I really suggest kind of keeping things simple and making the minimum number of assumptions that you can. But you know, if you look at your tax return, you can see the different categories for income that get taxed and look at each one of those and try to predict what you expect that income is going to be. So for instance, if you're a big real estate investor, you're probably going to have some real estate income. And if you're retired, maybe a lot of that is not going to be sheltered by depreciation anymore. So maybe you're going to have a lot of income from that. If you're working in a job where you're going to get a pension, then you could assume you're getting pension income. The big one that's sort of tuned is that the pre tax withdrawals and that's one that you can sort of tackle by just using the standard financial function called future value or fv. So what I presented in the talk was that you take your current pre tax balance and you can just look that up by going to all of the different brokers or firms that hold pre tax money, your workplace plan, your IRA, wherever it may be, and then assuming some sort of reasonable rate of growth, assuming whatever your future contribution plan is going to be, if you're working, you're contributing pre tax, you can put that in and then you're going to get a number for what your pre tax balance is going to be when you're retired. And then you can take a reasonable withdrawal rate of that like 4% and then that will be what your pre tax withdrawals are going to be. That will go on to your tax return. And then another big one is Social Security. Social Security taxation has some weird effects where if you're in this sort of phase in range where you your Social Security, the portion of your Social Security income that's taxable phases in rapidly up to the maximum of 85%, then you can get really high marginal tax rates in that. I think a lot of your listeners are going to be above that range, although certainly not all, but you can include that. And then if you're above that range, then you should just put 85% of your expected Social Security benefit on. And then I recommend doing this in real dollars. Social Security is indexed to inflation. You can use a real rate of return. So maybe if you're invested mostly in stocks, maybe 4, 5, 6% annual rate of return would be reasonable to assume for that. And then you can subtract any deductions. You know, standard deduction. The standard deduction for taxpayers who are over age 65 is higher. So you can take credit for that higher deduction. You know, if you're giving a lot of money to charity, you can, you know, put that in there and then you're going to get a taxable income. And then you can look that up in a tax bracket scale. And if you assume the tax brackets stay the same from where they are now, then you can estimate what your future tax rate is. And I think that's. It sounds kind of scary, but again, when you take this complex problem, you break it down into these little pieces, you solve each one on its own, and then you kind of fold those all back together, then you can get an answer. And fortunately, I think the tax code is a little bit simpler for taxpayers who are retired than when they're working a lot of these credits and things, child tax credits probably gone 199, a deduction is gone. You know, the earned income tax credit, you know, if that applies to anybody that's gone. So really, in my judgment, I think you should look at the normal tax brackets. And then the two effects you need to be aware of are this phase in of Social Security and then irmaa. And then if you do those check those three things, you can get a pretty good estimate for what your future tax rate is going to be. And then you can just compare that to your right now and then that will inform your pre Tax versus Roth decision. So again, it is complicated in a way, but I think if you, if you take a really systematic approach to it, I think it is doable. I think it should be within the reach of a lot of your listeners.

Yeah, I think it is within the reach of a certain percentage of our listeners. I think we just lost a whole bunch of listeners. I think that just went over their head and they're like, that's way too much work. Isn't there a calculator, isn't there some simple way I can just make this decision? And I've tried to use a Rule of thumb over the years where I basically told people that in anything other than your peak earnings years, you ought to make Roth contributions and in your peak earnings years you ought to make tax deferred contributions. And always with the caveat that there are some exceptions. What do you think about that rule of thumb? Do you think that works most of the time or do you think that's committing the sin of making things simpler than they can really be?

I think it's a good rule of thumb and it's one that I've used and it's one that I recommend to people. I mean, like any rule of thumb, there are exceptions to that and we can talk about a few of them. I think one exception would be if you're already in the top tax bracket and if your income and your wealth is so high that you expect to be in the highest tax bracket for your whole life, then that really leans things toward Roth. I mean, one of the normal advantages of traditional pre tax contributions is that most people most of the time have a lower tax bracket or are in a lower tax bracket when they're retired than compared to when they're working. And there are some strong reasons for that, right? Like most people need a little bit less income and then they've got forms of income coming in when they're retired that are not taxed. You know, like Social Security is only partially taxed, Roth accounts, you know, return of basis from taxable accounts and things like that. So it is, it's fair to say that the normal suggestion is that in your peak earnings years, pre tax is best. But you know, if you're always going to be in the top tax bracket, then you're losing that advantage. So then it's really just how much money can I contribute and get tax protected growth on? In that case, then Roth wins because you're able to contribute effectively more dollars in when you're contributing the maximum. But yeah, overall I think that's a pretty good rule of thumb. I mean, you have to sort of think about these other factors that we've mentioned that can skew it one way or the other. For instance, if you have an heir or you have a child who has a much higher or much lower income than you, then maybe you want to lean in that direction. If you're expecting to leave a lot of money from them. And again, all the other things we've talked about, if you are expecting to have a bunch of years where you're going to be able to Roth convert at really low rates, then maybe you want to lean more toward pre tax now even if your tax rate isn't quite as high. So yeah, there's of course exceptions to that, but I think as a good rule of thumb that one holds up pretty well.

Let's talk about some of the misconceptions and we've briefly discussed a few of these. But I kind of want to go over all of the ones you went over in your talk. The first one due to my low skill level in communicating sometimes I think I've been guilty of as well. And that is this misconception that you're supposed to compare your current marginal tax rate to your effective tax rate in retirement or your average tax rate in retirement. And I think what I meant when I would say that in the past, and I have a number of times, is that that marginal tax rate in retirement has to be a blended marginal tax rate. If you're taking out enough out of a tax deferred account, then to fill up multiple tax brackets, you have to consider the blended marginal tax rate on those withdrawals. And the same thing really, when you contribute, if you're contributing over multiple tax brackets because you have some huge cash balance plan that you can contribute pre tax dollars to, you have to consider both of those on both ends, that blending effect of it. But it really is the marginal. It's not your effective tax that you're comparing to.

Yeah, I think it is fair to say you should always use marginal. And the reason is that you can make the decision on whether to contribute pre tax or Roth for sort of each dollar. So you know, for instance, if you're this year you're in 2024 and you're, you know, you're trying to decide whether I should do pre tax or Roth this year, you know, most likely you already have some pre tax savings. So you know that savings is going to grow, we hope it will between now and when you retire and that any additional money you save in the current year and then in future years will sort of spend stack on top of that. Thinking about the future average rate, of course, if you're averaging over including all these low brackets, you're going to get a lower number and that's going to make pre tax savings seem very attractive. But I think the way to think about that is that if you have this blended rate, if you have all these low brackets in the future, that is reflecting the benefit of doing the first amount of pre tax savings, it's going to fill up all those lower brackets. And then once those brackets are already Filled up. Now again, I take sort of a plan centric approach to this. Right. So if you have, your plan is going to include what your current money you have now, any growth on that and any future contributions, if you have that plan that's already going to fill all those up, any additional money that you contribute on top of that is going to go all the way at the very top of that stack. So if you're trying to decide how much to contribute for this year, it's really your marginal rate in your future versus your marginal rate today. And that's the appropriate comparison to make.

Well said. We talked a little bit earlier about taxing the seeds versus taxing the harvest. I think we probably beat that one to death. But that is a very common misconception out there. So I wanted to mention that briefly. But another one you talked about in your talk that I have heard people say before, and I think you're right, that it's wrong, is that people say it's better to defer paying your tax as, as long as possible. Why is that wrong?

Yeah, so the reason is the math just doesn't work out to suggest that. So again, we talked about the sort of the seed harvest misconception. You're going to come out ahead paying basically the lowest tax rate as a percent. And it doesn't matter where along the timeline that tax gets paid. You know, if you, if you have money now, you take half of it now versus letting it grow to the full amount and taking half of it later, you're still going to end up with half of what you would have if there weren't any tax. So the idea that oh, you know, I don't want to pay tax now, I want to defer that until later, doesn't hold up from sort of a math perspective. The other reason it doesn't hold up is that the way pre tax retirement accounts are set up, the government makes sure that they're going to get a piece of that no matter what. Now that may be when you take withdrawals from it, that might be, you know, if you're taking RMDs when you're retired, that maybe if you leave it to your, you know, children or your heirs, they're going to take withdrawals, those are going to be taxed. So I think it's worth sort of comparing this to a taxable account. So with a taxable account you can get the step up in basis when you die, but there is no step up in basis or the equivalent of one for a pre tax account. You know, the government is always going to get their piece. So what I think about it more in terms of a pre tax account is you want to choose the lowest rate and then if you have the opportunity to contribute Roth now or to do a Roth conversion now, one way to think about that is you're sort of locking in the percentage that you're going to give to the government. And I think if you have reasonable confidence that the rate that you can contribute or convert at now is going to be less than what you could conceivably pay in the future, or that your heirs would pay, then I think Roth contributions are worth doing. The math works out differently for a taxable account. So like I said, for a taxable account you can get the step up in basis. So deferring capital gains, I think is usually the right answer. And that's sort of the standard financial advice. The other difference is that for capital gains, let's say you have, I don't know, $1,000 of unrealized gains in your account. If you defer paying taxes on that, you're paying the same tax on the same thousand dollars with future dollars. So it's more of like sort of a fixed dollar tax. Do you want to pay $150 now or you want to pay $150 in 20 years? Well, obviously the future payment is going to be better because you get 20 years of tax protected growth on it. But that's not the case for a retirement account because the percentage is really what matters. So it really is just the game of do I want to pay the tax rate now at whatever percentage is available, or do I want to wait and expect to pay a lower rate in the future?

Your next common misconception that you brought up in the talk is one that I love to hear because I am a total believer in this one and I get this question all the time. People think there is an optimal ratio of pre tax assets to Roth assets that you want to have going into retirement, and sometimes they include pre tax to Roth to taxable assets that you want to somehow make changes throughout your career to arrive at your retirement date with this optimal ratio. Why is that a misconception?

Yeah, I mean, there's nothing about the math that says that there's some sort of best ratio. I can give you examples where somebody is best off with 100% pre tax, and I can give you examples where someone is best off with 100% Roth. So, you know, an example 100% pre tax is, let's say, somebody who is maybe they're getting a late start on their savings. You know, they're in their 50s already, for whatever reason, they haven't started saving and they're, you know, they have a high tax rate now. You know, they may only work for another 15 years. And saving 100% pre tax and getting all that pre tax savings now is going to pay off because their taxable income is going to be kind of low when they're retired and they're going to be able to fill up all those lower brackets. They're not going to go up into the higher brackets when they're retired. So, you know, if you give me an example of a person like that, I would say this person should be doing 100% pre tax wherever they can. Now. I mean, for instance, if it's like an IRA and your deduction is phased out and your only choice is the backdoor Roth, that's that or taxable. The backdoor Roth is going to win. So you'll have some Roth money in that regard. But yeah, that person should be contributing pre tax if they can. And then another example on the other side is somebody, let's say they have a great pension, you know, they've got a, you know, $150,000 pension or something. And you know, any pre tax savings that you're going to make is going to come in on top of that $150,000 and you might pay a really high rate on that. So if that's the case and you're able to pay a lower rate now or even a similar rate if you're contributing the maximum, then you'd be better off doing 100% Roth and you can go into retirement with zero pre tax dollars. If you have that pension. And there's absolutely nothing wrong with that. It's just whatever the math says is going to be the best thing to do.

I love it. You don't get a pass on math. You know, speaking of somebody that likes to say you don't get a pass on math, Dave Ramsey likes to say that. But you know what else he says is another common misconception about this? He tells people pretty much every time when they ask him this question that they should do Roth, that Roth is always better. What do you think? Why is that such a misconception out there? Are people just ignorant? Is that why they're making that recommendation?

Well, I can't get inside Dave Ramsey's mind, so I don't know whether he doesn't understand it or whether he's making a very Simplified recommendation for his target audience. So on a mathematical level, I would say no, that's not correct. There's lots of situations where pre tax is best. And again, you know, if you look at sort of the average American, the average person who sort of has, you know, a normal career progression and a normal retirement, pre tax is going to be the right answer for that person. You know, and especially if you look at sort of the average population, I think I read that the, the average like net worth of somebody who's in their 60s is like four or five hundred thousand dollars. Well, if you have, if all of that is in a pre tax account and you're taking, you know, 4% withdrawal or so, that's barely enough to fill up like the lowest brackets. Like the standard deduction is, you know, for a married couple, it's like 300, excuse me, it's like $30,000. So, you know, if you have $400,000 and you're taking 4% of that, you're not even going to get above the standard deduction. So you're going to basically going to be paying no tax in retirement. So pre tax is going to be the best option for there. I think what Dave may be going after is that there is a behavioral aspect to finance and to this decision. And if the choice is to contribute either pre tax and spend the money that you save on taxes on something that is not valuable for your life, or you save it in Roth, then in that case, Roth is the better choice. And we've talked a lot about numbers in this. I'm an engineer, I love the numbers. You're an enthusiast in this topic too. But at the end of the day, the behavior really matters. 80, 90%. And the math just kind of gets you that last little bit. So if Dave is thinking that he's trying to work around behavioral tendencies of his audience and if they may be tempted to spend the tax money rather than do what we talked about in this podcast, which is to save it in a taxable account and invest it very tax efficiently and maybe leave it preferentially to your heirs so you get to step up a basis and do all those things. If somebody's not doing those things, then the Roth is a way to actually trick them into saving more. And most people don't have close to optimal financial behavior. And if that's the situation, then that's what, that's probably what I would recommend too, if I were approaching somebody that I thought that that was a possibility for. So there may be some more wisdom to that than you think. But, yeah, it's hard to really know what he's thinking with that.

Well said. Well said. All right. One of the other things that I thought was really cool from your talk and you got to it toward the end is you talked about splitting contributions. Now, I've often told people that they're not sure what to do. Do half tax deferred and half Roth, and at least they'll be minimizing their regret. Only with half their money did they do the wrong thing. But you pointed out at least one scenario where that can actually be the optimized move to put some money into pre tax and some money into Roth. Can you describe what that sort of a scenario might look like?

Yeah, sure. So marginal tax rate is, I think, best thought of not as just one number, but as a curve over the range of income that you have. And the simple example is, you know, if you're sort of toward the bottom of your tax bracket, like, let's say you're, you know, in the bottom of bottom $10,000 of the 32% bracket, and then let's say you look up, your tax rate is 32%. Okay, that's high enough. I want to contribute pre tax. So you contribute the $23,000 elective deferral limit this year, you're not actually saving that 32% on that whole contribution. You're getting a lower rate on more than half of that. So my suggestion to people who are trying to sort of take this problem seriously is to look at the whole curve of your tax rate over the range of contribution options you have available to you. And a lot of people will find that they are. There's some tax cliffs as they go down where they are going to end up saving less taxes than they expect. So if you're in that situation, you can split your contribution. You can contribute, you know, enough to get you down into the next lower bracket, and then once you're in that lower bracket, then you can contribute the rest. Roth. And that's a way to get sort of a mathematical advantage from splitting contributions, not just sort of a psychological one.

Well, Chris, we've lost a ton of people in this discussion. I mean, we're way out in the weeds here when it comes to personal finance and investing and taxes. And you and I love to nerd out on this. We think it's awesome, super fun. It's our hobby. But that's not the case for everybody listening to this podcast, and they're wondering, what if they make a mistake? What if they do Roth when they should have done tax deferred or done tax deferred when they should have done Roth. How big of a deal is it?

Yeah, most likely it's not that big of a deal. And I think you hit the nail on the head earlier, which is that to acknowledge that retirement accounts are a great option that the government gives you to save for your own retirement. And they give you these big tax benefits, big asset protection benefits, big estate planning benefits in exchange for saving for your own retirement and taking care of yourself when you're older so that the government doesn't have to come in and take care of you. That's sort of the way that I think about it. So this is really a, a big advantage to either pre tax or Roth compared to just saving in a taxable account. So I definitely recommend for, for everybody if you can contribute the maximum, you should be doing it. And it's better to save in retirement accounts than it is in taxable most of the time. That said, when I look at numbers, I've looked at, ran the numbers for my own case, for my own family and then for a lot of other people, the difference ends up usually being pretty small. I think it's around 5% the difference. If you look at maybe let's say 24 to 32%, that's 8%. So that'd be kind of on the high end. But most of the time you're probably within. If it's a reasonably close call and you're not saving at 12% and you're going to pay 40% later on, if it's not one of these sort of extreme cases, then that I think is a good sort of rule of thumb for what you can expect to save by doing really good sort of tax planning on this. And I think about it in terms of how this stacks up with your other financial priorities. So I would say priority number one is to just save a big percentage of your income so that you have for a high income earner a six or seven figure portfolio. If you're not saving and you got to just work on your budget. Second priority I would say is getting your asset allocation ready. If you're looking at the difference between let's say an 80% stock portfolio and a 20% stock portfolio over 35 years, it's about half. So that's getting your asset allocation right, that's like 50% of your nest egg. I'd say probably third priority would be getting your fees down. So a 1% fee will eat up over 35 years, about 20% of your portfolio. So once you've done those things, then I think Pre Tax versus Roth is probably the next thing should be considered. Again, if you go with that 5% number, that ends up being equivalent to about a 25 basis point difference in your investment performance over 35 years. And so to put that in perspective, I'm actually not a huge nerd when it comes to the actual investments. You could, I'm sure, teach me a lot about small cap growth versus small cap value. But let's say somebody has a 10% small cap allocation and they're trying to get an extra 1% growth out of that. That's only like 10 basis points over your whole nest egg. And that is less significant than pre Tax or Roth. So that's sort of where I see it sort of stacking in. But one of the other things I'll say is that this is a problem that involves a lot of uncertainty. There's uncertainty about future tax rates, about your future investment growth, about your career. How much am I going to be earning, what state am I going to be living in? All these things are very difficult to predict. And we've all had unexpected changes and all those things that affect this analysis. So I think it is worth putting in some effort and trying to do it right. But if something changes, if your income goes way up or goes down, then there's really nothing you can do about that. And I don't think that's worth having regret over. I think that you should tell yourself that you had you made the best decision that you could at the time with the information you had available, and that should give people comfort.

That is just awesome advice, Chris. That is just perfect. The wonderful thing about it is the harder this decision is for you, the less it matters, right? If it's not completely obvious that you should be doing one or the other, it doesn't matter as much. So that's kind of a beautiful thing about it. For those who are really on the fence and not sure exactly what to do or what assumptions to use. Well, Chris, I think in this discussion you have established yourself as a force in the online personal finance community. I think it's been really impressive how much thinking you've done on this topic and how well you've encapsulated your thoughts and simplified them enough to be able to teach the rest of us about them. Thank you so much for doing that. Thanks for being a speaker at WC Icon and thanks for being on the podcast.

Thank you very much. It's been an honor.

All right. I hope you enjoyed that interview as much as I did. I actually got several things I'm not sure I had a very concrete understanding of, you know, clarified through my discussions with Chris and watching his talk, you know, doing this podcast. So I hope it was just as helpful to you. His best recommendation for online written material to check this out is on the Bogleheads Wiki on this topic. It's very long, very extensive, but goes over a lot of these same topics. We also have a number of posts on the White Coat Investor blog, Tax Deferred versus Roth. You search those terms, you'll come up with three or four different blog posts that can help you to think more about this topic. If you're looking to boost returns, lower taxes and build wealth, join the WCI Monthly Real Estate Opportunities list for tips and strategies to maximize your real estate returns. And for introductions to exclusive investment opportunities, expect educational emails that introduce you to syndicators, fund companies, online courses, and online real estate platforms. Go to whitecoatinvestor.com reopportunities to sign up today. You can do this and the White Coat Investor can help. Don't forget about Those physician surveys whitecoatinvestor.com Physiciansurvey you can sign up to take them, get paid for your opinion money you can make while you're watching TV or commuting or whatever. And check that out for an additional side gig, additional source of income who couldn't use a little bit more income in their life. Thanks. For those of you leaving us a five star review and telling your friends about the podcast, a recent one came in from Chris the Pacer fan. He really enjoyed the episode we had with Alexis Galati on taxes. He said, wow, this was packed with Alexis reviewing several great tax strategies. Thank you. Five stars. We appreciate that review and we hope some of you feel it was worth giving Chris a similar five star review for this podcast. You can do that wherever you download your podcast and it will help others to find this podcast and bring them financial literacy and discipline. And the combination of the two in our financially illiterate world is like having a superpower. It really does make it possible to create a pretty incredible life for you and help a lot of others along the way. So keep your head up, your shoulders back. You've got this. We're here to help. Thank you for being in the White Coat Investor community and we'll see you next time on the White Coat Investor Podcast.

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