I want your retirement to be awesome, I really do. Most of the inputs in getting you to an awesome retirement is going to be as a result of your actions, namely you turning your time and energy into money (otherwise known as work) and then turning some of that into capital (or savings, for the lay-person). From there we try to maximize it by growing it via investing and then, finally, keeping Uncle Sam at bay by legally limiting your tax liabilities. These two items are where many need assistance.
So to back up, how you save matters because taxes matter because taxes impact how much you actually get to spend (or give). Your decision on how to save and invest today could realistically impact your annual take-home income by 3%, 5%, 10%, or, with really careful planning, even more! If your income was otherwise going to be $60,000 in retirement and you can add 5% that ends up being an extra $3,000 for you to enrich your and/or other people's lives. Think about it, that's a nice weekly get-away to somewhere warm during the cold winter of January ... or ... April (sigh), every single year.
This. Topic. Matters.
Anyway, how about some context first?
For a number of years my primary job - then at Fidelity Investments - was as an Investment Education Consultant. In truth the title was a bit of a misnomer as I was more of an Investment & Financial Planning Education Consultant, in that I talked on nearly all personal finance subjects, not just on investing.
I'd estimate that I spoke to roughly 12,000 people a year, give or take, on varying subjects in personal finance. It was more often than not a huge challenge. Much of the time, especially early on, I was ill-prepared. I didn't fully realize the depth of knowledge necessary to be an effective educator on a very specific subject.
Here's my point in bringing this up: there are many ways to learn the nuances of a craft but I'd argue one of the best is fielding questions from approximately 12,000 people a year. Being a speaker on the subject was an excellent educational experience. I thought I knew financial planning when I entered the role ... yikes was I wrong.
Visual Representation Of Me Starting Off
The Situation As I Thought It To Be
The Reality of the Situation
The power of the crowd was incredible and their questions forced me to research and develop thought processes on things that I didn't even know that I didn't even know. Note that many of the questions a crowd has are verbally unasked; it's only after-the-fact - through surveys or reviews or personal conversations - that the speaker finds out his or her message left questions unanswered. This process really humbled me (which I'm sure many people thought was coming to me) yet also sharpened me.
Note that I really had only three things that I absolutely had to be good at in order to be successful at my job: 1.) Being On Time (time management is important when a crowd of 100+ people are waiting to hear you speak) 2.) Public Speaking (not just the act of speaking but fusing relevant information with a delivery that isn't snooze-worthy, which required practice, confidence, and extremely careful planning) and 3.) I needed to know in advance the answers to the questions the audience was going to ask - put another way, I absolutely had to develop a knowledge of both broad and deep practical application of the topics I talked on.
Of all the questions asked, and there were a lot of them over the few years I was in this role, I'd say that the single most common one was, "Should I be saving in a Roth?" As such, I've put a healthy amount of thought into this subject.
*Quick primer on Roth vs. Pre-tax (and other types of accounts). The primary - though not only - difference is when you pay taxes. See here for a visual of this.
This is actually a very nuanced question and one that doesn't get nearly enough deep thought put into it by many in the personal financial advisory industry.
I've had the great fortune of being exposed, through multiple avenues, to an extremely wide swath of advisers in the industry. So many of them are so much better than I am in many different facets of financial advisory services. With that being said, though this is purely anecdotal, the vast majority of them simply don't do a lot of thought processing on managing client wealth in a tax-sensitive way, including application of this question. In fact, the most common and mostly automatic responses I've heard are:
"Yes, everyone should be saving in a Roth IRA if they can afford to."
"It doesn't matter whether you save in a Roth IRA or pre-tax account, you end up with the same amount of money."
"Young people should definitely be saving in a Roth."
"Diversifying your savings approach is good."
Now, all of these responses are generally correct, it's just that the full truth, in personal finance, is always nuanced and so using these as the be-all, end-all prescriptions will lead to less total wealth for a lot of people. So really we should be asking if we can get more granular with the question of who should be using Roth and who shouldn't. I found out, during my time doing daily workshops on the subject, that there are a million and one exceptions to every rule on the subject of personal finance and this applies to Roth usage as well.
So beyond the general suggestions that young people should be using a Roth or everyone if they can afford it should be using it or we should all be seeking to diversify our savings, are there more specific examples of who should be using the account? Well, here are a few types of people that almost without question should be saving in a Roth before saving in a pre-tax account. *Disclaimer: this is informational only; everyone should be doing a personal analysis of their own situation, either independently or via a financial planner, before determining how to save.
Who Should Be Using Roth?
1.) You have a pension that will mostly or entirely provide income replacement.
Though there are some other considerations to the Roth vs. pre-tax question (some of them extremely nuanced), the majority of the consideration is this: save in a Roth account if you think your taxable income in retirement will be higher than it currently is and save in a pre-tax account if you think your taxable income is higher now than it will be in retirement.
This is a pretty difficult thing for the vast majority of people to determine with certainty yet there is one group who mostly knows the answer to this for sure: pensioners.
I have multiple clients who are police officers, though pensions come in different shapes and sizes, these individuals each know that, should they continue to be police officers for 25, 30, 35 years, they will have a pension that will provide at least their current income and possibly more. Any dollars a police officer with a pension saves in a pre-tax account will have to be taken out above their pension. This means that they could be distributing their pre-tax dollars at higher rates than what they saved them at (this is especially true in light of the temporary tax cuts from the TCJA). This is just flat-out poor tax management.
Point being: saving in a Roth over a pre-tax account is a near no-brainer for people who have a full income-replacing pension (most commonly public-sector employees).
Again, have a pension? Roth is very likely better for you than pre-tax.
2.) Your employment prospects point to substantial increases in the future.
It is very true that young people in general should be saving in a Roth over a pre-tax account. In my professional opinion this is true for probably 95%+ of people in their 20's. The reason being is that most people earn more in their 30's than the 20's and more in their 40's than their 30's, and so on. Income just tends to increase over time for many/most people.
However, this rule-of-thumb is based off expected income trajectories. It is fully possible for an individual or couple in their 20's to be better off saving in a pre-tax account.
Why? Well, what if we have a couple of 27 year old's who are both working but decide they want to start a family and go down to a single-income household? Well, it's quite possible that their age 27 year is the highest the household will see from an income perspective. This made-up couple should probably be saving pre-tax now and then switch to Roth later.
So do a quick analysis of your future. Expect higher household income in the coming years? Use Roth, not pre-tax.
3.) You're 10+ years from retirement & all of your current retirement assets are pre-tax.
The recent tax reform has provided a 10-year window wherein rates are lower for the vast majority of people then they previously were, and more importantly in regards to this subject, where they will be 10+ years from now.
Tax Cuts & Jobs Impact On the 25% Marginal Tax Bracket
So if you're retiring in more than than 10 years then even your first distribution will be at a rate that is higher than it is now - assuming your income needs are the same in retirement as they are now.
A lot can and will change between now and 2027 but we plan with the information that is known and right now we know that rates are scheduled to increase. If it's true that we should save in a Roth over pre-tax when our tax rate is lower now than in the future then anyone who is 10+ years (and especially those without anything in Roth already) from retirement should be strongly considering saving in a Roth!
So is a Roth a good idea? Yep, for a lot of people but especially so for these 3 sub-categories of people.
Making better decisions on how to save requires you to move along the spectrum from randomly guessing (what most people do) to using a rule-of-thumb (what many people do) to personalizing the approach - which is unfortunately the road least traveled.
There's a lot of money on the line with your decisions, make sure yours are informed.