Why you should (almost) never contribute to a Roth 401(k)

One of the most popular questions we get here is Roth vs Traditional. It’s a tale as old as time. Pay taxes now or pay taxes later? In general, given the higher than average incomes present on /r/personalfinance, the advice errs toward “Traditional 401k, Roth IRA”.

There are a number of excellent resources supporting this thought process including the following:

Roth or Traditional from the Wiki

Roth Sucks - One of the originals, but less robust then the following examples

Madfientist - Includes focus on early retirement

Roth v Traditional IRA PDF - Somewhat simpler but focuses on traditional IRAs, which

The Finance Buff - Concepts similar to this post

Money with Katie - Includes robust analysis

and I’m sure many more. If you’re reading this and have a better article on the topic, I’d love if you left it in the comments.

But I’m going to take a different angle on why you should (almost) never contribute to a Roth 401k instead of a traditional 401(k).

For many high earners, Traditional 401(k) provides the single largest available tax avoidance vehicle

While there are a number of tax deductions/credits available for individuals, many of those phase out at relatively low incomes (at least in comparison to the higher than average incomes we see here). This means they may not be available for you to use at all or they may require traditional 401k contributions to drop your AGI low enough that you can claim them.

Student Loan Interest deduction - Phase out begins at $70k if single or $145k if married
Traditional IRA Deduction (if covered by a retirement plan at work) – Phase out begins at $73k or $116k
Child and Dependent Care Tax Credit – Phase out ends at $43k and 20% credit for expenses

Additionally, changes to the standard deduction as part of the 2017 Tax Cuts and Jobs Act have greatly reduced the number of people who itemize their taxes. Prior to TCJA, approximately 31% of tax payers itemized. As of 2019, that number was only 13.7% - https://taxfoundation.org/standard-deduction-itemized-deductions-current-law-2019/

Prior to the TCJA, tax payers received both a Standard Deduction ($6350 for single, $9350 for head of household, and $12,700 if married) and a personal exemption worth $4050. Further, there was no limit on the deductibility of State and Local Taxes (the SALT limit). This means it was relatively easy for a single homeowner to itemize their taxes, as they only needed mortgage interest, property taxes, and state/local income taxes to exceed $6350 and they continued to receive the personal exemption. For example, a single tax payer who paid $3000 in mortgage interest, $2500 in property taxes, and $3500 in state income taxes would have total itemized deductions of $9000, plus a personal exemption of $4050, totaling $13,050 in deductions. Compare this to the standard deduction of $12,000 (with no personal exemption) in 2018. Further, the SALT limit is $10k per tax return rather than per taxpayer, making it significantly more difficult for married couples to itemize without substantial mortgage interest, charitable giving, or unreimbursed medical expenses.

Given the limited availability of tax deductions under current tax law, it rarely makes sense to give up the largest tax break available to you. Of note, many provisions in the TCJA expire for tax year 2026, so this part of the analysis may change if and when Congress passes new tax law.

A second reason to avoid Roth 401k is due to the large number of additional Roth options available.

Roth IRA allows direct contributions of $6.5k (as of 2023) up to a MAGI of $153k if single, and backdoor contributions with no income limit
Megabackdoor Roth allows for upwards of $43,500 as of 2023, if your 401k plan allows for after-tax contributions and either in-plan conversions or in-service rollovers.
Starting in 2024, SECURE 2.0 requires all catch-up contributions for those earning more than $145,000 to be Roth (of note, SECURE 2.0 erroneously eliminated all catch-up contributions, but this is expected to be corrected by legislation or IRS guidance)
Strategic conversions allow tax payers to convert traditional 401k/IRA balances to Roth in low-income years.

In many cases, people suggest Roth 401k early in one’s career. That can be a mistake, especially if this person plans on returning to graduate school, for instance. Take, for example, a person who works for two years at $50k/year before returning to a two-year graduate program. This person contributes $7000 each of the two years, saving him $840 in taxes. During graduate school, he does not work or otherwise earn income. During the tax year he has no income, he can convert that balance to Roth, for free as the amount is less than the standard deduction. He pays no taxes on contributions, he pays no taxes on the conversion, he pays no taxes on earnings, and he pays no taxes on withdrawals in retirement.

Times you may want to consider Roth 401k.

All that said, there are some limited circumstances where I think Roth 401k can make sense.

Substantial Income Increase Imminent: I call this the resident doctor exception. Since resident MDs earn such little income in their first few years before their income jumps substantially, it can make sense to contribute to a Roth 401k in those years before their income jumps by 4-6 times (or more) without a low-income year in between.
Partial Year High Earner: This is the “college graduate exception” and applies to someone who only works a partial year in a high income job. Using Roth 401k lets you take advantage of tax brackets and standard deductions being applied across an entire tax year when you only work for 3-6 months of the year.
High ordinary income in retirement: If you have a large pension or significant real estate holdings in retirement, you'll quickly fill up your lower tax brackets, making the tax benefit from Traditional 401k less attractive. If you maintain a high savings rate early in life, Roth 401k can make more sense. That said, pensions typically (but not always) come with lower-paying government jobs and IORR requires upfront capital outlays, which may impact your ability to save substantially. Further, if you do save substantially early in your career, you may be primed for early retirement, which may put early retirement roth conversions on the table (see the Madfientist link above).

Other scenarios

Low-income career: For those who do not expect to be high-earners (or marry high earners), traditional is typically better than roth throughout one’s career, as you are less likely to save substantially and social security will make up a larger amount of your income in retirement. This thread discusses the topic well, so I won’t rehash the topic: https://old.reddit.com/r/personalfinance/comments/miqe7p/401k_and_ira_planning_for_low_income_earners/
Financial Independent/Retire Early: Given their early retirement, FIRE-types will have more low-income years to engage in roth conversion ladders to reduce total taxes across their lifetimes. I won’t do this topic justice so I’ll just direct you to /r/FIRE, and /r/financialindependence
Marginal Utility of Dollars: For those who are saving heavily for retirement marginal utility of dollars in retirement (when you're flush with cash because you saved so much) will be lower than the marginal utility of dollars when you are young and have little wealth. Even if you aren't quite 100% tax efficient in retirement, it will hopefully not matter because you already have more than you can spend. This doesn't apply to everyone, but certainly does apply to the people who save a lot.
Tax-Free gifts to heirs: Inherited Roth IRAs provide tax-free distributions to your heirs. Depending on your wealth level, it may make sense to contribute or convert to Roth accounts to pass down tax-free money to your heirs, especially if they have a higher marginal tax rate than you do.

I'd love to hear your thoughts, especially if you can think of scenarios that I haven't. I don't plan on getting into the math much since I think the links provided at the top do that pretty well.

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