The traditional tax deferral model made more sense when marginal tax rates were higher --> federal rates were 33% for $35,200 and 42% for $60,000 of taxable income in 1984. You can roughly multiply these by 2.5 to get them into todays dollars ($88k and $150k, respectively). The idea was you’d see a lower tax rate in retirement than during your working years, which was the case when far more people were paying taxes.
Now, the number of brackets are reduced, and the rates are lower on most people. Current marginal rates are 22% up to $168k (all figures are married, filing jointly, but it’s a similar story for the other filing statuses).
Aside from the question as to whether you will have higher tax rates when you retire, Roth accounts have another VERY valuable benefit – by having lower taxable income in retirement, you may not surpass the point where Social Security is taxable to you (or less of your Social Security benefit may be taxable when you receive it).
A few years ago, there was a proposal in Congress to require all future IRA/401(k) contributions to be of the Roth variety. This was clearly a budget balancing initiative, since Congress would effectively raise tax revenue. Retirement “tax breaks” were cited as the #3 tax “expenditure” according to the government, following healthcare and mortgage interest deductions (the latter maybe falling in rank post-tax reform) – these other two are sacred cows to most Americans (i.e., the voting public), so removing those benefits would have caused an outcry.
I looked at a few different income levels back then, and I was surprised to find that for most people, Roth wasn’t really detrimental. Actually, it was beneficial on a few different fronts:
- the Social Security Benefit tax issue discussed above (mostly applicable to lower-middle income people),
- It allows people of all income levels to save more (in value). $6,000 (IRA) / $19,500 (401(k)) post-tax with interest is worth far more at retirement than the same amount pre-tax. Yes, I realize you need to contribute more (e.g., if you are in a 22% tax bracket, you’d be contributing the equivalent of $7,692 or $25,000 on a pre-tax basis for the IRA and 401(k) limits, respectively. But you’d have that same higher multiple of retirement value down the line, unless you think your taxes will be lower in retirement (either due to your retirement income or due to overall changes in tax policy)
- For the people who already max out their retirement savings (contribute the $6,000 or $19,500) and invest/save other money for retirement in taxable accounts, Roth is a “no brainer”. You are already investing after-tax dollars, but the income on those is fully taxable. So a high earner in the 24% tax bracket (or higher), you can contribute these amounts post-tax and will never be taxed on them again (assuming you meet the Roth withdrawal rules).
Personally, a mix of traditional and Roth makes the most sense to me. You’d have some taxable income in retirement (and save some taxes today), but you’d also have some non-taxable income in retirement (which could have other benefits like reducing the portion of Social Security Benefits that are taxable)…