It seems that Roth conversions and funding Roth 401(k)s instead of tax-deferred 401(k)s is all the rage these days. But the million-dollar question that needs answering is whether it mathematically makes sense.
2025 How America Saves Report
112 Pages from Vanguard
Vanguard just released a report with a bunch of very interesting stats advisors can use with clients. To download this report, click on the following link:
Here are some stats that led me to write this newsletter:
85% of employees who have access to employer retirement plans are contributing
7.7% of wages is the average deferral amount (an all-time high)
12% of wages is the total average contribution when adding in employer contributions
$148,153 is the average employee account balance
84% of participants use Target Date funds
18% of pension participants make Roth contributions (an all-time high)
$12 trillion (the amount of assets in defined contribution retirement plans)
What the above stats tell us is that advisors should be focusing on this HUGE marketplace!
Why tax-deferred 401(k)s (as well as IRAs, SEPs, etc.) are better than Roths
Most clients will NOT be in a higher income tax bracket in retirement!
Most advisors are unaware of or simply do not think about the concept of income tax bracket inflation. Federal income tax brackets shift upward every year. Many retirement planning software programs do not increase brackets every year. If you don’t, the client will be in a higher bracket than in the real world, making Roth contributions and Roth IRA conversions look better.
Let’s look at a simple example—
-45-year-old couple earning $80k a year each ($160k total annually (pre-tax))
-The couple’s “effective” income tax rate is 14% (they are in the 22% top bracket)
Let’s say they have ZERO money saved (including in tax-deferred 401(k)s)
They really need to start saving, so let’s say they can collectively defer 12% of their salary ($19,200) annually into their tax-deferred 401(k) plans at work until they retire at age 65.
Let’s use the following assumptions for their retirement:
https://advisorshare.com/vanguard-ee-savings-report
Collective Social Security (SS) incomes starting at age 65 = $95,000
$121,800 in retirement expenses starting at age 65
Account balance of the tax-deferred 401k(s) for both spouses = $1.053 million at age 65
4.5% NET rate of return on investments during retirement years.
2.7% for inflation, 2.7% COLA SS increase, 2.7% income tax bracket inflation
When does the couple’s 401(k) run out of money? Age 88.
What if the couple at age 45 started funding a Roth 401(k) instead?
Using their 14% effective tax rate, I netted down their annual Roth contribution to $16,512.
Account balance of the tax-deferred 401k(s) both spouses = $905k at age 65.
When does the couple’s Roth 401(k) run out of money? Age 86.
Why did the client run out of money early when funding the Roth 401(k)?
Because their effective income rate in retirement is projected to be lower than the rate while in their working years. Their effective income tax rate in retirement is projected to average only 10.5%.
The key number the client will care about is that their cash flow shortfall in retirement when funding the Roth vs. the tax-deferred 401(k) = $116,279!
OnPointe Retirement Planning Software
Help provide better advice to your clients by using OnPointe’s retirement planning software:
https://onpointesoftware.com/retirement-planner-software
The numbers from this article were run in OnPointe, and it took me less than 5 minutes to run them. OnPointe not only projects what the client’s current effective income tax rates will be annually in retirement, it does so much more.
-Only accurate IRMAA penalty app
-Only accurate Roth IRA conversion app
-Best tool in the industry to help clients understand sequence of return risk
-Seamlessly add FIAs to increase retirement cash flow
-Seamlessly add FIAs with income riders to increase and guarantee retirement cash flow
-Online lead-gen widgets for both Roth Conversion and IRMAA
New Roth IRA Conversion Consumer Video
If you didn’t know, OnPointe’s Roth IRA conversion software is what we call the “only” accurate software of its kind in the industry. When advisors find out how inaccurate other software is, we believe they will revolt and start using OnPointe (so better recommendations can be given to clients and so advisors can avoid lawsuits).
The following is our first attempt at a consumer educational video on Roth IRA conversions. I’d appreciate you watching this video and giving feedback . It’s a tool OnPointe will be able to customize and on websites, Facebook, LinkedIn, etc.
