This Loophole Makes Traditional 401(K) Better Than Roth [2023 Update]

Having an optimized investing strategy can mean extra tens of thousands of dollars *per year* in retirement—and I'm breaking down how you can get the most bang for your buck with the Traditional 401(k).

This show is a production of Morning Brew and is produced by Henah Velez and me, Katie Gatti Tassin. Devin Emery is our Chief Content Officer. Our video editors are Christie Muldoon, Sebastian Vega, and Nichole Friedman. Additional fact-checking comes from Kate Brandt.

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I’m Katie, a personal finance content creator on a mission to make everyone else as obsessed with their financial health as I am. With small tweaks and just a little more awareness, you can live a richer, happier life. I started writing about money in 2018.

#MoneywithKatie #Money #Retirement #PersonalFinance #401K #Traditional #Roth #Traditional401k #RothIRA

00:00 Traditional or Roth 401(k)?
00:15 Why a Traditional 401(k) could be better
02:00 Katie’s experiment
05:27 Roth vs Traditional numbers
07:08 Katie’s ultimate strategy
07:59 M1 Finance’s high-yield savings account

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[TheManInBush]

insane break down - changed the way i think about roth vs traditional and I really love all the number crunching showing why and how it is better. thank you!

[AlexMorgan-tinv]

I never though of investing tax savings from a traditional 401k elsewhere, eye opening and incredibly smart

[Cody]

I’m going to give three reasons why I prefer Roth over traditional and won’t ever bother with traditional 401k

1. Estate planning.

If you plan on using a traditional 401k do realize you are leaving a tax trap for your heirs to inherit. If you have 400k in pre tax 401k and you die and aren’t married the account is going to be converted into an inherited IRA given to your heirs if you are taking RMDs when you die your heirs will also have to take RMDs and pay taxes on those RMDs. Most likely your heirs are going to be younger and in their prime earning years so they are going to get taxed more due to higher income then a retiree.

If you have a roth 401k and it gets turned into an inherited IRA guess what? Your heir/s don’t have to do RMDs and don’t get taxed on that money. That is huge bonus for Roth compared to Traditional in regards to passing on legacy wealth.

2. You don’t plan on liquidating your portfolio.


Look if you have a really large 401k in the millions when you go to retire your RMDs are going to be heavily taxed. The tax you will have to pay because of RMDs.

If your money is Roth and in the millions then you don’t have to liquidate your portfolio if you have for example 4 million in your Roth 401k and you roll that over to a Roth IRA and you get 4% dividends through ETFs and/or stocks that is 160k a year 100% tax free.


3. You already heavily contribute to a taxable account.


I already dump almost 20% of my gross income into a taxable brokerage account on top of Roth IRA and 401k contributions. If your like me and already do heavy contributions to a taxable account the “investing the tax savings into a brokerage account to make more money then Roth” is redundant. We put money into Roth specifically to not pay taxes on that money in the future.


I could list a few more reasons but those are the three main reasons I prefer Roth over traditional.

[stephtraveler]

I did what you just described over the last 25 years... and the numbers work out almost exactly as you described. I never rebalanced, but I also never sold. Just held and let it recover, but point is: Maxed traditional 401k and invested the remainder post tax in Roth, in the years I qualified and conversions in the years I didnt.
Great analysis. Smart girl!

[drewjohnson]

I’ve heard arguments the other way, but enjoyed the perspective. I actually split mine down the middle.

[keithmachado-ppfv]

I like this thought process and agree with most of the points. I do challenge the “top down” vs “bottom up” analysis. It makes the correct assumption that the Roth tax is paid at the highest tax bracket you are in at the time, which makes sense because at a minimum you have wages and perhaps other income. However on the withdrawals from the traditional, the example shows paying tax starting in the 10% bracket. That assumes no other income. At a minimum, during RMD time, you will have SS income and most people with large IRA balances likely have other income, such as a pension, annuity, dividends/interest income, so the tax on the withdrawals will go on top of this income just like the Roth does up front.

[bernadofelix]

Great video. We are all seeking for financial independence and a better way of life. This is not difficult to achieve with savvy investing, a frugal lifestyle, and cautious budgeting. I'm glad I learned early on to work hard for financial independence. As Warren Buffet said, he has seen this happen many times in his life. Not an investor, My husband and i never earned more than a middle class salary. We plan to get retired at 58 with a stock portfolio worth $1.7M. We have never sold so much as one share of stock.

[knightmare]

My 16 year old self would have never thought I would be watching this. Thank you so much for your advice/content.

[Amelia-Elizabeth]

Amazing video, A friend of mine referred me to a financial adviser sometime ago and we got talking about investment and money. I started investing with $120k and in the first 2 months, my portfolio was reading $274, 800. Crazy right!, I decided to reinvest my profit and gets more interesting. For over a year we have been working together making consistent profit just bought my second home 2 weeks ago and care for my family.

[brandonswan]

Finally. Someone who understands this question properly. Im sad that i can only give one thumbs up.

[allysonlleatherwood]

Stings to learn this in my 30's but glad to know before it's too late.

[kortyEdna]

The 401k is good, because retirement choices determine a lot of things. My parents both spent same number of years in the civil service, but my mom was investing through a wealth manager, and my dad through the 401k. My mom retired with about 4.2 million, but my dad retired with roughly 1.8 million. So it really does.

[brandonscott]

Most people who have enough money to max their 401ks will also have additional streams of income like real estate. With factoring that in, I believe the tax free returns would prbobably be better over a longer time horizon. Plus, behaviorally most people won't invest the difference and then roth is a huge winner. I spilt 50/50 roth / pre and max roth ira on top of it. Should allow me to have flexibility in where I am pulling from depending on other taxable streams of income. It is nice to hear someone firmly on the side of pretax, as most other financial youtubers are roth lovers

[josephjones]

2:47 The most valuable part of the video for me was setting a realistic expectation of 25 year retirement. It's almost comical when I hear some financial planner expect the average person to invest from 40 - 50 years consistently. From what I have seen, most people don't start thinking about retirement 30; even if you do contribute regularly, life gets in the way.

[brianrothenberg]

Katie, thanks for creating this video. I like your approach. However, I think for the tax rates in retirement, you should factor in social security payments. I'm not sure how that would affect the outcome, but I think it would make the comparison more realistic.

[Take_Your_Time_I_Can_Wait]

My biggest concern as someone who plans to retire at 65 is if I’m investing in pre-tax for my 401K, starting at 59 1/2, I can do Roth conversions, but those conversions can change the tax bracket I’m in for those years, which can cause me to pay IRMAA premiums since IRMAA makes its calculations based on a 2 year look back. Granted, that gets calculated annually, but with the amount of money I plan to have in my 401k by then, I’ll be doing the Roth conversions for a WHILE if it’s all in pre-tax. Maybe doing a split between traditional and Roth would be worth it. At least HSA lowers taxable income, so it balances out some.

[cesarcharolet]

I would love to see you and The Money Guy Show have a sit down on a podcast since they follow the “all Roth all the Time” for 401k and to see you both bring the data on why 1 or the other is better.

[wlaw]

This was a great episode. Appreciate the deep dive!

[keithmachado-ppfv]

I stand corrected on my earlier comment challenging the top down vs bottom up comment. Upon further investigation, I have 12 years before RMDs to figure out how to get all my income other than SS to zero. This will be accomplished by investing in municipal bonds, cash value life insurance, MLPs, and stocks. Then I will be able to withdraw my RMDs taking advantage of the standard deduction and lower tax brackets (both which are increased annually for inflation).

[keithmachado-ppfv]

I prefer a brokerage account to a Roth, where I can harvest tax losses, defer tax gains, and where my heirs get a step up in basis and don’t have to liquidate the account in 10 years.