Investing in a Retirement Account is Like Taking Out a Loan

Traditional retirement plan contributions come with a loan attached to it with a variable rate of interest, to be determined at a later date by the tax code and your income level. #interestrate #interest #loan #IRS #taxesEver since the FIRE (financial independence/early retirement) movement hit the scene I started to question conventional financial wisdom. 

Most of the advice preached was re-purposed from generations past. A penny saved is a penny earned turned into a variety of frugal anecdotes. You can’t read Proverbs (from the Bible) and not recognize the many similarities in advice. Sound money principles have ancient roots.

For a time the FIRE community welcomed me as one of their own before I stepped back a bit to cut my own path. (No sense in another voice calling out the same message.) I’m still part of the community, but gave myself permission to question the dictums of said community. The hope was to build a bridge from where we are to a higher level.

It also became clear my net worth was near the top of the demographic. This bothered me and caused me to conclude something was wrong.  How could a backwoods farm boy with nothing more than a high school education, a few college courses and a full personal library do better than virtually all within a community so dedicated to wealth?

I don’t trust luck to carry me that far. It had to be something else.

Then I started reading what was published in the tax field and felt a great disturbance in the force. While the advice was fundamentally sound, it also lacked in effectiveness if brought to task. All too often blogs were using IRS publications as their authority. (The IRS is NOT a tax authority; they are a bill collector.) If people followed this advice and the IRS ever challenged (likely with so many people tempting fate) there was a real risk of loss. (If you go to Tax Court and say you used an IRS publication as your substantial authority you lose automatically even of you a right! IRS publications have zero authority in Tax Court.)

Sometimes the math was fuzzy. A blogger might claim a certain level of frugality when it didn’t add up. Some claimed a level of wealth that also didn’t add up. Either the rules of mathematics were suspended or someone was trying to pull the wool over their reader’s eyes.

The biggest area of concern involved retirement accounts. The mantra of filling retirement accounts to the hilt for long periods of time has some obvious issues

Some retirement account problems are less apparent. Everyone keeps saying this is the best thing since sliced bread. But is it? 

So I started running some numbers and it wasn’t as clear as most are led to believe. There was something fundamentally wrong with the advice.


Numbers Game

The issue is with traditional retirement accounts (IRA, 401(k), 457, 403(b), Keogh, profit-sharing and cash balance plans); Roth type retirement plans don’t have this issue.

Don't lose your retirement account to hidden taxes. Current tax savings are dwarfed by future taxes on all the gains at the highest rate allowed by law. It's your money! Don't give it to the IRS. #retirement #account #hidden #taxesRoth style retirement plans don’t get an up-front deduction, but grow tax-free. Most financial blogs consider this the best animal in the yard. I agree.

A close cousin — if you qualify for it — is the health savings account where you get a deduction and tax-free growth, to be used for qualified medical expenses. The biggest drawback of the HSA is the amount you can invest annually is relatively small. 

Roth retirement plans are limited in many cases based on income on if the employer has the option in their 401(k) . The maximum Roth IRA contribution is also relatively small. (Exact limits are excluded from this post so changes in the limit don’t distract from the evergreen content.)

The mega-backdoor Roth (a favorite of the FIRE community) allows for sizable Roth contributions with one caveat: it’s probably illegal (according to the IRS). The IRS hasn’t attacked the mega-backdoor Roth because there is no current revenue to be raised by taking such action; Roth investments are not deductible.

However, once these accounts grow in size the IRS could come back and disallow the tax-free advantage, plus interest and penalties. If the IRS has a kind heart (ahem) they could forgo the excess contribution issues which would certainly mean penalties several hundred percent of the entire investment. You decide what course you wish to take. 

The safest retirement plan route means traditional retirement plan investments after you maximized your Roth contributions. Or is it?


Loan Document

Traditional retirement plan contributions come with a loan attached to it with a variable rate of interest, to be determined at a later date by the tax code and your income level.

All you debt-free warriors should feel a bit nervous at this point. Just as a mortgage-free home still has loan-like obligations (property taxes, insurance, maintenance), a traditional retirement account has an unannounced interest-like expense and it is a big one.

And this is what disturbed me so much that I had to publish a post on it. 

We all know that traditional retirement accounts get a tax deduction at your ordinary tax rate up to the retirement plan contribution limits. We should also know that these accounts grow tax-deferred and that all distributions are taxed at ordinary rates.

This is a real problem if your goal is to maximize your net worth. In the early years the tax benefit makes it seem like it is the best deal on the planet. But as time passes the math tells a darker tale.

Let’s start with a simple example to get a fundamental understanding of this matter:

Joe contributes $10,000 to his t401(k). This is subtracted from his income on the W-2 and never reaches his tax return. His tax bracket is 30%.

We will disregard actual tax brackets as they change over time and we are more interested in a workable formula for determining the best course currently and for future readers as well.

The good news is Joe saved $3,000 on his taxes this year. However, in 40 years, when Joe retires, he discovers his investment in a broad-based index fund performed as index funds have over long periods in the past: around 7% per year on average. Joe is a very happy man! He now has $149,744.58. 

If Joe were to take the entire amount in one year it would be a fairly large tax. However, Joe decides to take the money out over a number of years. As a result his ordinary tax rate is only 15%. (We will disregard taxes on Social Security benefits and other similar issues to make calculations easier.)

Joe now has a tax bill of $22,462. (Numbers are rounded.) That is $19,462 more in additional tax! Call the 19 grand a tax or anything else you want, but it looks like interest on the $3,000 to this accountant.

Even though Joe saw his tax rate decline by half in retirement he still saw his tax bill increase over 700%. His interest rate would be slightly less than 5.2% annualized in this situation assuming Joe never saw his account value increase after he started taking distributions, an unlikely event.


Early Payments

If I approached you and said I would borrow you $20,000 at 5.2% would you take it? Unless you have bad credit that is a high interest rate, especially since it in not deductible. Worse, you can’t make early payments to get out of the deal! You can’t jump ship until you are at least 59 1/2 years old. And if you are stubborn I’ll kick you overboard at 70 1/2. 

The good news is I’m a nice guy and will not do that to you. On the other hand, Congress has passed laws the IRS carries out doing just that.

And we haven’t seen the worst part yet! Retirement plan distribution included in income can cause more of your Social Security benefits to be taxed and can also increase the premium you pay for Medicare once you reach age 65.

A small tax deduction today can do real damage in the future. This is why I say I want multiple tax benefits before I get excited about a tax deduction

All this assumes your tax bracket drops when you retire. Considering the massive government fiscal deficits during a strong economy, it seems to this accountant taxes will go up in the future. And if your income remains high in retirement your tax bracket will also be higher.

Consider this: If Joe had a 30% ordinary tax rate on his retirement plan distributions his taxes would have climbed to $44,923, a full 7% annualized rate. For people with good credit this is a massive interest rate and almost nobody is thinking about this.


The Cold Equations

Joe’s example is unfair. First, Joe will put a lot more into his retirement plan over his lifetime, therefore, the damage will be much larger.

Second, retirement plan distributions happen over a number of years. While this might sound like a solution to the problem, it actually makes it worse as the investments continue to grow over time.

Third, smaller account balances experience the same issue only with smaller numbers and that tax rates might be lower due to the lower income level.

Fourth, early retirement does not solve the problem. Yes, you can take a limited amount of money from a traditional retirement account before age 59 1/2 without penalty under Section 72(t). This only reduces the amount of time the money has to grow; it doesn’t resolve the issue.

No matter how you cut it, traditional retirement accounts are best viewed as loans from the government, due in retirement. If you don’t pay the piper, your beneficiaries will.




Your experience will differ from that of others. You can use the simple example above to determine your implied interest rate assessed as tax in the future. You may discover this isn’t an issue for you. Or, you might need a moment for reflective prayer.

We saw that greed for a current tax deduction produces a 5%+ interest rate loan from the government, payable in retirement. So, what alternatives are there?

The best comparison is doing nothing at all (investing in a non-qualified account). You still invest in the same index fund. Dividends and capital gains are taxed at the lower long-term capital gains (LTCG) tax rate (15% or less for most taxpayers) instead of ordinary rates later (up to 37% federal, plus state income taxes). 

Since the money is outside a traditional retirement account you don’t have to worry about early distributions or required minimum distributions. And if you die your beneficiaries get a step-up in basis the retirement accounts don’t get. Gains on these investments are also taxed at the lower LTCG rate. 



I can hear the complaint already: What if my employer matches?

A valid argument. We’ll go back to Joe again and assume his employer matched his contribution 100%.

Joe invested $10,000 of his own money and his employer matched his retirement plan contribution with another $10,000. 

Joe still gets a deduction worth $3,000 for his contribution. The employer’s match is free money and not taxed until Joe takes the money out.

In total, Joe has $20,000 invested in his retirement account. His account grows to $299,489 in 40 years. The tax on this at a 15% tax rate is: $44,923. 

The initial tax benefit to Joe is $3,000, plus $10,000 from his employer, for a total of $13,000. The implied interest rate in this situation is around 3.15%.

The lesson of this part of the story is that using your employer’s retirement plan up to the match maximum is still a good idea for most. After hitting the matching maximum you might be better served putting the rest into a non-qualified account, however.


Smart readers will also be quick to point out the extra tax savings means you have more to invest which mitigates any of the extra taxes owed in the future. This would be true if people actually did that.

When was the last time you invested your tax savings from a traditional retirement account investment? Where did you invest it? Uh-huh. Thought so. You spend the tax savings as most do.

(If you are one of the few who actually pull the tax savings from the family budget and invest it in a non-qualified account my hat comes off to you. You still need to run the numbers to verify the best course of action.)


Facts and Circumstances

You can’t read tax law for more than a few minutes before running across the words “facts and circumstances”. And this situation is no different.

The IRS has hidden interest-like charges on retirement accounts. Here is how to avoid them. #avoidtaxes #taxes #retirement #IRS #interestI gave you the tools to build a working plan based on your facts and circumstances. Use a future value calculator to determine the interest rate the tax code is forcing you to pay if you use traditional retirement accounts. 

Employer matching is a real benefit that is diminished by the tax code after very long periods of time. (I would focus on the employer match closely as real value can be found there.)

After the employer match and available Roth retirement plan contributions allowed are exhausted you might find non-qualified accounts the best course of action, for you

The important thing is that you are reading this. That means you are more likely to run your numbers for the best options, for you

There are a lot of factors at play. Index funds still kick out dividends and some capital gains which are currently taxed. This slightly reduced the implied interest rate of the traditional retirement plan if you are prone to investing tax savings. It also assumes you keep your fingers off the pile until retirement. 

The one thing to remember is that deferred taxes frequently come with an implied interest rate paid as a higher future tax.

This is the kind of stuff I think about in the dark of the night. It might also be the prime reason I top the net worth list at Rockstar Finance.



More Wealth Building Resources

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cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

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Keith Taxguy


  1. Jim on June 17, 2019 at 8:44 am

    Curious what happens in your analysis if the capital gains rate increases? When does it alter your analysis?

    • Keith Taxguy on June 17, 2019 at 9:16 am

      Jim, one blog post can’t cover every detail. I thought about many of these issues and had to decide what to include and to exclude.

      What would really be nice is if a reader IT skilled built a calculator on this with Excel or some other platform. I’d do it on Excel, but time is limited and my IT skills are as well. Hint, hint to all readers who can program/code.

  2. Yaacov Rothman on June 17, 2019 at 8:53 am

    Don’t know if you did this on purpose or not, but you are totally discounting the added value that the deferred tax gave you (namely the 100K extra after taxes).
    At the end you need to look at maximizing income/value, not (only) minimizing total taxes paid.

    • Keith Taxguy on June 17, 2019 at 9:18 am

      Yaacov, I mentioned this, but it does get buried in the text. The added value of the retirement account/non-qualified account only grows larger than the after-tax traditional retirement plan contributions if you actually invest the tax savings. My experience is that virtually no client ever does this.

      • Yaacov Rothman on June 17, 2019 at 10:47 am

        You mean that the $3,000 (from the example) needs to be invested in a traditional account?
        That makes sense, though most FIRE people invest in both anyway.

        So the loan is higher interest the more money you put in deffered tax accounts vs. taxable, and potentially there is a break even point the more money you invest in taxable accounts in tandem with the deferred.

        Thanks for the clarification!

        • Keith Taxguy on June 17, 2019 at 11:46 am

          Let me clarify, Yaacvov. If you would normally save 10% of your wage into a t401(k) and your tax rate in 20% you need to save 12.5% of your wage to equal the after-tax rate of 10%. Since many readers max out their retirement accounts the money still needs to be invested in a non-qualified account. My example assumes the tax savings consumed since that is what most people do.

          • FullTimeFinance on June 18, 2019 at 11:17 am

            I have to disagree with the logic here a bit. If the argument is they didn’t invest todays tax savings then where did it go? Ie unless they actively made a decision to spend the extra tax rebate doesn’t the assumption have to be they saved it. If the put more in their 401k this year because they had less money going to taxes this year then de facto the money was invested. Similarly if they chose to drop it in another account or on the mortgage. Only if they chose to spend this years savings above and beyond preplanned levels did they not invest the savings.

          • Rob on June 29, 2019 at 4:24 pm

            Are we also considering every dividend, any interest, and any capital gain distribution along the way. Those gains are taxed along the way year after year for decades in the regular account. You’re also earning interest, dividends, and distributions on your untaxed gains which accrues continually.

  3. Kady on June 17, 2019 at 8:54 am

    Between this and “When Adding to Your Retirement Plan is a Bad Idea”
    I’m not sure that I would slow down my contributions but, since I can’t max out (percentage cap on contributions) I will 1. continue to use a Roth rather than traditional IRA and 2. get a brokerage account started.

    Thank you for questioning conventional wisdom even the conventional wisdom from a group whose hallmark is challenging conventional wisdom.

    • Keith Taxguy on June 17, 2019 at 9:21 am

      I think you got it right, Kady. The pecking order is HSA or Roth, then Roth, followed by traditional retirement accounts. The only way to determine the best course from there is to put pencil to paper and make some serious calculations. Would love a reader to build a calculator for this I can share.

    • josh on June 17, 2019 at 11:39 am

      Would you recommend using a roth 401k over the brokerage account? The added benefit is tax free growth and dividends, but we lose flexibility on the withdrawals. Right now we can max the wife’s 401k, both roth ira’s, and have another$20k going into the taxable account. I personally would prefer less in 401k and more in taxable as it is more flexible and we do get the REAL double tax benefit of taking capital losses today while deferring LTCG out into the future when we can take them when we want to (no RMD).

  4. Leo on June 17, 2019 at 9:28 am

    If you run your numbers on a person with slightly higher income, then the numbers do not seem to reach the same conclusion as this article. I was going to add an example here (so you could see where I’m going wrong), but the WCI just published an article that says it all:

    • Keith Taxguy on June 17, 2019 at 9:39 am

      That is why I reiterated facts and circumstances, Leo. There are so many variables one blog post can cover without extending too long nobody will read it. For example, I linked to another post where I discuss multiple tax advantages with one action. Example: A traditional retirement contribution might increase certain credit (EIC, Saver’s, PTC, etc.). Adding these issues change the formula. Another issue is how much Medicare premiums will be once you hit 65 and income tax on Social Security benefits. There are a lot of moving parts, for sure.

      What I do know is that well over half of all taxpayers get it wrong because they don’t know the right move and nobody taught them how to think about it the right way and make the calculations.

  5. Carol Prather on June 17, 2019 at 10:28 am

    This is really amazing. Thank you so much!!

  6. Cathleen Cooks Stuff on June 17, 2019 at 11:21 am

    What about those at the top of the ROTH IRA tax bracket that are trying to bring down their AGI? (of course, we are under the assumption that the tax benefits for the ROTH IRA will remain the same indefinitely, and that the taxes for taxed investment accounts will also be kept indefinitely as they are now). It was my assumption that above-the line deductions would lower the AGI, thus for people right at the border of the phase out for contributions to the roth, would enable them to fully contribute. Maybe I am wrong.

    • Keith Taxguy on June 17, 2019 at 11:48 am

      That is why I say facts and circumstances. There are so many variables that a single blog post can be all inclusive. What you suggest is part of my “double benefit” tax strategy. If a traditional retirement plan contribution allows for a larger Roth contribution it might be worth it.

      • Cathleen Cooks Stuff on June 17, 2019 at 7:08 pm

        Thanks- I do realize it’s hard to cover everything in a single blogpost. And you are very correct in that many people will not invest or save the difference- they’d probably just fritter it away. The question is basically my situation, thus the maxing out (up to the contribution limit) of my 401k/TSP. Husband doesnt get a match at all, so there’s no point unless we need the decrease in AGI so we can contribute to the ROTH IRA. Another “benefit” I like is that I can borrow (and pay back to myself) the TSP up to $50k for a measly $50 or something…IDK if I’m running the numbers right, but that seems to me a bunch better than paying someone else 4% or whatever for a mortgage on a home….but have to look into whether that % for the repay to myself (since its to buy a home in this example) is also a tax write off since its interest. But it’s to my tax deferred retirement….so,….hmmmm. I will definitely consult a qualified local professional when the time comes.

  7. Triple Fi Guy on June 17, 2019 at 11:25 am

    Interesting post Keith! It definitely gets the reader thinking about their tax situation and conventional wisdom. I do think the main thing to follow like you stated is look to see if a traditional contribution has multiple benefits.

    One consideration for myself is that long term capital gains and dividends are taxed at full rate in a non qualified account where I live (Oregon) which is 9% on top of federal.

    I also like to build my cash pile up during the year and then once I know my tax situation come February, I can then decide to max out Roth/traditional and or funnel some into non qualified since my tax situation has changed every year.

    • Keith Taxguy on June 17, 2019 at 11:51 am

      Triple Fi, I’m aware of OR taxes. They really bite. That is why I hounded on facts and circumstances. Once I flesh out the federal tax issues I could spend a thousand pages dicing the state tax laws.

      One thing you can consider is if you a likely to stay in OR when you retire. The tax break is worth more if you get a “better” deduction now and only pay federal income taxes later. Just a thought.

  8. The White Coat Investor on June 17, 2019 at 2:37 pm

    I disagree that looking at it as a loan is the right way to look at it. You state you’re going to ignore the tax brackets (i.e. marginal tax rates) but in reality closely examining them is the only logical way to make the Roth vs tax-deferred decision. In my post published today,

    admittedly aimed squarely at high earners, I make a strong case that most docs and similar earners in their peak earnings years should be using tax-deferred accounts, and then discuss factors that might lead one to conclude they are an exception to that general rule. of thumb.

    But it’s all about the tax rates. There’s no loan here, so trying to compare it to a loan could potentially cause one to arrive at the wrong conclusion. In reality, a tax-deferred account is part yours and part the government’s that you invest on the government’s behalf for a few decades before giving it to them. If you can get part of the government’s account to be moved into your account by having a lower effective withdrawal tax rate than your marginal tax rate upon contributing, then you come out ahead. The opposite, of course, is also true, but much more rare. Hard to make as strong of a case for someone making $50K a year as someone making $500K a year (the tax code is actually far more complex at $50K of income with all the phaseouts and credits), but the same principles apply and the decision should be made the same way-by examining the tax rate at which you save taxes on contribution and the tax rates at which you withdraw the money.

    • Mr. Hobo Millionaire on June 22, 2019 at 12:13 pm

      WCI, all the math I’ve run as a high earner comes to the same conclusion you did in your post, and it’s not even close.

  9. Eric on June 17, 2019 at 4:29 pm

    I think your analysis with the “Joe” example is a bit flawed. I don’t take issue with the math showing $22,462 of tax vs. $3,000 of tax, but I do take issue with the conclusions you draw from it. You’re comparing a pre-growth number to a post-growth number. It’s apples and oranges.

    What if Joe had instead taken that $10k of pre-tax income and invested it in a Roth IRA instead? He’d pay $3,000 in tax this year, the remaining $7,000 would grow roughly 15-fold over the next decades (just as it would have with the traditional retirement account), and he’d be left with nearly $105k. This amount is all Joe’s to keep since it’s in a Roth account, so he gets to rest easy in knowing that he saved $19,462 on his taxes. Or does he? Note that even after paying the tax on his traditional retirement savings, the original Joe got to keep more than $127k. I don’t need a degree in accounting to see that $127k is more than $105k.

    The number of dollars you pay in tax is a red herring. What matters is how much you keep after paying your taxes. For this, you mostly just need to look at the marginal tax rates. In this example Joe is better off with the traditional retirement account because his tax rate went down in retirement compared to when he was working.

    Now, you do bring up a number of good reasons why one should not automatically assume that their tax rate will be lower in retirement. The phase-in of taxability of social security earnings, the possibility of increased tax brackets in the future, and the possibility of really large RMDs are all things that a person should take into account when making their guess as to what their marginal tax rate might be in retirement. In the end it really is a guess: do I think my tax rate will be lower now or later? Between legislative and market uncertainty it’s not something one can really pinpoint to a great degree of accuracy, but an educated guess is possible.

  10. Christopher on June 17, 2019 at 10:23 pm

    Thx for running thru that lesson professor! But for those among us who already done drank that koolaid …do you have thoughts on which of our buckets we should spend down first? (Traditional, taxable, etc?)

    • Keith Taxguy on June 18, 2019 at 7:54 am

      Christopher, I don’t think past advice to fill all retirement accounts is wrong. As the demographic that super-charged their retirement plan funding grew it was time to illustrate that it might be wise to step back and reevaluate going forward. As I mentioned in the post, Roth plans are excellent; I see no downside with them. Filling an HSA if allowed is also a desirable course. Of course even this comes with caveats. If you are really healthy you may never need the HSA money. You can use it to pay Medicare premiums after 65, but by then you will have more in the HSA than Medicare premiums will consume. You can use HSA funs at 65 as a retirement plan, buuut… then you pay tax on the distributions (no penalty). There always seems to be a catch in taxes.

      Then you need to push a pencil to determine the correct level of traditional retirement account funding. Facts and circumstances will prevail.

      This really isn’t all that new, Christopher. People have been converting tIRAs to Roth accounts for a long time when it fits their, wait for it, facts and circumstances. My goal was just to get people thinking about it. I hope it helps you make the best possible decision for you.

  11. KEB on June 18, 2019 at 7:35 am

    Shouldn’t your “cost” calculation be an opportunity cost based comparison? You mention as an alternative that the reader should invest normally in the stock market and get the 15% capital gains tax. Then in the rest of the article you use a tax payer with a 15% tax rate (makes sense, they are retired and slowly pulling from the 401k balance). Well in this scenario it is awesome that they invested in the 401k. Most individual investors are not very savvy and get frightened during market turns. Or pull from the stock market when extra cash is needed (versus its hard to pull from 401k until retirement). Plus they got all the matching and growth from their employer for free! (15% tax in either scenario) But you just mention the tax costs without any real opportunity cost analysis. I can agree on the Roth approach IF the person believes tax rates will increase in the future (definitely true for anyone retiring in the next couple years).

  12. Abe on June 18, 2019 at 7:54 am

    Great advice recommended savings, especially in a roth account. We are using the same technique for kids and grandkids, especially since reading “Income tax Shattering the myths” by Dave Champion and finding out that Congress has never mandated a income tax on the average American citizen. Thank you for service and the article is very helpful.

  13. R on June 18, 2019 at 12:46 pm

    Why mega-backdoor Roth probably illegal according to IRS? Could you elaborate please

    • Keith Taxguy on June 18, 2019 at 2:53 pm

      I was waiting for someone to ask that, R.

      First we have to define what we mean here. The backdoor Roth is not illegal in the traditional sense where you contribute to a non-deductible IRA and immediately convert to a Roth. The TCJA clarified this a bit making it likely an acceptable transaction. IRS attorneys agree.

      However, the mega backdoor Roth promoted by many bloggers is not as clear. This involves (numbers are for 2019) maxing out your 401(k) and then filling out the rest of the secondary limit of $56,000. Let’s use an example:

      You contribute $24,000 into your 401(k) and your employer, let’s say, matches $6,000 for a total of $30,000. You can elect to withhold up to $56,000 from your wage/salary, the annual max for those under age 50 at the end of the year. This means you can elect to have a non-deductible withholding from your wage/salary into your 401(k) of $26,000. If your employer allows in-service transfers, you can immediately transfer these non-deductible funds to get them into a Roth IRA. Hence, the “mega” backdoor Roth.

      The IRS is divided on the issue. Some IRS attorneys think this is covered by the TCJA. making it more likely to pass IRS scrutiny. Many IRS don’t like it either. They consider it a structured transaction.

      If the IRS decides to fight this in the future it will be a mess. The good news is that more and more IRS attorneys are warming to the concept. But…

      • R on June 18, 2019 at 7:26 pm

        Interesting. I thought that if corporations like google make mega back door available to their employees we don’t have to wary about IRS, but sound like one never knows

        • Keith Taxguy on June 18, 2019 at 8:10 pm

          History is littered with behavior the IRS approved and then changed its mind. Google the disabled access credit tax scam. The IRS and tax attorneys claimed it was all legal until the IRS said “Nope.” That was big in my area so I got plenty of clean-up work. All we avoided was penalties because the IRS told these people it was okay to do it. They still owed the tax and interest.

      • Todd on June 27, 2019 at 7:40 pm

        Hi Keith,

        I respect you immensely, but I respectfully disagree with your statement “The TCJA clarified this a bit making it likely an acceptable transaction.”

        Footnote 268 of the TJCA was unequivocal in its affirmation of the Roth backdoor. I’ve pasted it below for reference:
        “Although an individual with AGI exceeding certain limits is not permitted to make a contribution directly to a Roth IRA, the individual can make a contribution to a traditional IRA and convert the traditional IRA to a Roth IRA, as discussed below.”

        Moreover, the TJCA isn’t some IRS publication. It comes from Congress, so it is authoritative guidance in its purest form.

        – Do you really think the backdoor is still only “likely” acceptable?
        – And as for the mega backdoor, what is your source when you say “Some IRS attorneys think [the mega backdoor] is covered by the TCJA”? I’m am genuinely curious to learn more about why you are so cautious here? Would you recommend your clients proactively unwind a mega backdoor now?


        • Keith Taxguy on June 27, 2019 at 8:31 pm

          The TCJA is law but it still needs regulations so we know how the IRS will interpret the law; not as easy thing, Todd.

          I know I’ve stated the potential problems with the mega backdoor Roth in the past. Usually when I mention this issue it is when I’m trying to illustrate why bloggers with little to no tax experience act as if they do. It irritates me because I’m the one that has to clean up the mess when the proverbial manure hits the fan.

          That said, I still recommend the mega backdoor Roth to clients with the warning the IRS may change its position in the future. I also would not unwind a current mega backdoor Roth if you have one. The IRS has serious issues challenging the mega backdoor Roth and that is why I think it will be around for a long time. First, the IRS gets no benefit (procuring additional tax revenue) by challenging a taxpayer and winning. Also, I think the IRS has serious issues challenging later due to the statuette of limitation. (Do they retroactively disallow the tax-free gains? Can we say, “Supreme Court?”) Honestly, I don’t know how the IRS reasonably attacks this no matter how much they hate it. It’s the main reason they have held back, IMO.

          I bring this up periodically because some people really think they know what they’re doing when it comes to taxes. I’m suffering burn out from all the work cleaning up these messes (and I have a national footprint so I attract a lot of the big problems). Bloggers have quoted me (WordPress shows me where link traffic comes from) incorrectly. I never jump in and tell them they are wrong because that would be a full-time job. Many don’t read tax law or my work close enough and make some serious errors.

          Tax law is bad enough. Tax Courts in different districts sometimes disagree with each other. If they struggle with it, how can a layman reading a few web pages make a definitive argument? Doesn’t professional designations and experience count for something? And why are these people so confident until the IRS audit letter arrives? Then I’m a smart guy all of a sudden.

          When it comes to tax law, humility is a good trait. The arrogant eventually get humbled. And there is one thing I also have. There are IRS auditors who were once my employees. I have trained IRS auditors. And, the IRS reads this blog to see how I interpret certain tax facets. I’ve been told by insiders I really do a deeper dive on tax issues than almost anyone out there. Most people who hear me speak before a group in a Q&A realize quickly how encompassing my tax philosophy is.

          Finally, your reference to footnote 268 is a misunderstanding. This footnote is talking about the mainstream backdoor Roth where you invest in a non-deductible tIRA (regardless of income level) and convert to a Roth. When I’m talking about the mega backdoor Roth I referring to the retirement plans being maxed out to the profit-sharing levels made popular by the Mad Fientist. I agree with Brandon, but fully understand the IRS does not. If it blows up we know who’ll be called in to clean up the mess.

          • Todd on June 28, 2019 at 5:49 am

            I appreciate your thorough reply. I understand the frustration involved in a career of cleaning up messes – hey, it keeps the larder full though!

            Regarding the footnote in the TCJA, I was indeed referring to the mainstream backdoor only. Sorry, if I was unclear. I was just surprised to hear you say it is only ‘likely’ that the mainstream backdoor is acceptable (in the comment above you said, “The TCJA clarified this a bit making it likely an acceptable transaction”). The 2017 law seemed to clarify beyond a reasonable doubt. I would say the regular/mainstream backdoor is law now, but I could be wrong.

            As for the mega backdoor, I appreciate your insight. I’m certainly no expert, but the statute of limitations (not to mention the fungibility of contributions and associated gains) would seem to present a high hurdle indeed.

            Please keep up the great work!

          • Keith Taxguy on June 28, 2019 at 6:54 am

            I was concerned I was coming across with an attitude, Todd. Glad I was able to clarify some. The wording in the post may have caused some of the confusion. I might reword a bit so it is clearer. Occupational hazard for bloggers.

  14. Jason on June 18, 2019 at 1:04 pm

    I’m afraid that I’m not following your math on this. Are you saying that because the total dollar amount paid in taxes is greater when using a traditional, we should ignore the fact that the growth minus taxes will still be higher and use a Roth instead? There are only a few reasons I can think of when a Roth is superior to a traditional IRA/401k.

    1) Government increases taxes. While taxes might increase, I highly doubt that any politician is going to support increasing taxes on the middle class. Anyone who keeps their net worth below $3 million and their AGI below $100k is going to be safe from tax hikes.

    2) They have no income tax to defer. If due to low income or a lot of other deductions and credits, a person’s effective tax rate is 0%, then a Roth is a better idea. I have a Roth IRA for this very reason. After maxing out a 457b and a 401k, along with various credits, I don’t have anything left to defer.

    3) Their expenses in retirement will exceed their income during accumulation years. They don’t just have to be higher than expenses during working years; they have to be higher than income before it becomes worthwhile.

    4) They want to make things easier for heirs.

    If you need the numbers in front of you to prove it, I have a spreadsheet here:

    • Jason on June 18, 2019 at 1:15 pm

      Also, having a high net worth doesn’t make a person correct. I’m sure Dave Ramsey’s net worth is higher than yours and most other financial bloggers, but that doesn’t mean he is giving optimized advice. Some of us are content to get $1-2 million and stop trying to earn anything other than dividends and capital gains.

      • Keith Taxguy on June 18, 2019 at 2:55 pm

        Net worth doesn’t make me correct, but I’d recommend people listen closer to Warren Buffett than to me. If the net worth is earned (I inherited nothing ever) they have something that is working and it is worth at minimum considering.

        • Jay on January 6, 2020 at 4:57 am

          I am confused about your post. If you use 3k in pretax dollars, you have more money in the market. Assuming you are in the 30% tax bracket, if you pay taxes first, you would only have $2100 to invest (Paid $900 in taxes upfront) . Using $2100 to invest in after tax accounts, you still need to pay 15% LTCG. Wouldn’t you gain more long term with 3k invested with higher returns even though you have to pay more taxes later

    • Jason Clapp on June 20, 2019 at 10:28 am

      This is interesting food for thought. I’ve been consuming a lot of FIRE content for a couple of years. This is one of those those great pieces that helps with perspective with a somewhat contrarian view, but in a nice way.

      I’ve just finished clearing out the consumer debt from my balance sheet. My wife and I have been working the numbers to determine where and how to put that debt service money. HSA and Roth are near the top in the traditional savings categories. We have a laundromat and car wash business and are trying to decide if some investment in that will be better. We also have a small real estate investment company (one sfr) and think about adding more there.

      Thanks for the post. It has added another piece of the puzzle that helps bring detail and issues to consider, even if it doesn’t make the decision easier. Facts and circumstances, right?

      The good thing is that we talked with our financial advisor last week (a fiduciary) and will be meeting with our accountant next week to help us with our specific situation.

      Thanks for another great post.

  15. Adam on June 19, 2019 at 6:49 am

    Interesting article. The retirement account situation in the uk has some advantages over the US. You can draw most pensions at 55 not 59.5. Also can take 25% tax free, and balance at marginal rate, which if below 12.5k is also tax free. This gives uk savers an incentive to save in retirement accounts for tax relief, tax free growth, and withdrawals tax free. However this may change at the whim of legislators. I guess the decision of mix of retirement accounts and savings accounts comes down to which options best reduce taxes and fees as these have such a big impact over long term savings, and how you intend to draw these down and spend them.

  16. Liz on June 19, 2019 at 5:57 pm

    Last year we saved 10% in a Roth. This year I wanted to maximize our earned income credit so I started saving in a traditional account instead. Because of the tax savings we save 20% of our income and almost see no change in our take home pay. That extra 10% invested is bound to cover the future taxes and more….

    • Keith Taxguy on June 20, 2019 at 7:56 am

      This is exactly the kind of thinking I was hoping to promote, Liz! When you review your personal situation to ferret out multiple benefits from one action you really take command of your finances. If you also gain from credits (EIC, PTC, Saver’s Credit, etc.) over the deduction of the retirement plan contribution you are in the driver’s seat.

  17. Liz on June 19, 2019 at 6:11 pm

    I forgot to mention that with the earned income credit for every $50 less we make (put into a traditional) the government gives us $10 so why wouldn’t we? Am I wrong here?

    • Keith Taxguy on June 20, 2019 at 7:58 am

      You are 100% correct. Your situation clearly indicates adding to a traditional retirement account. The future tax will not exceed the multiple current tax benefits.

      • Actuary on FIRE on June 21, 2019 at 8:37 pm

        As someone above says you’re comparing apples and oranges by comparing today’s money with a future amount. You’re comparing $3000 in tax paid today with $22,462 tax paid in 40 years.

        You need to discount the future value by your discount rate of 7% to the present day. And… 22,462 discounted by 7% for 40 years is precisely $1,500.

        Why isn’t it $3,000? Because the future tax rate was half.

        So it all stacks up. The taxes are identical and of the same value. By deferring tax with your 401k the government has lent you the money to invest and you pay them the appreciated tax at retirement.

        If the discount rate was. 0% then it would literally be comparing $3,000 and $1,500.

  18. Dallas J Bateman on June 23, 2019 at 11:07 pm

    When I first read this, I was really excited to calculate dropping my 401(k)–or at least only contributing enough to get the full employer match–and start saving strictly to my taxable brokerage account after my HSA and Roth. When I read the article again, I began to question the benefit.

    You gave the example of Joe investing $10,000 in a traditional 401(k) and saving $3,000 on taxes as a result. The account grows to almost $150,000. When withdrawals are taken, Joe pays about $22,000 in taxes (15%). You claim this is like $19,000 in interest on the $3,000 tax savings.

    Just a thought. Let’s say Joe invested $10,000 into a taxable brokerage account instead, so he doesn’t get that $3,000 tax break. That $10,000 still grows to nearly $150,000 with or without a prior tax break. When he takes out that money, he still pays 15% LTCG, which is the same $22,000 tax bill. But that’s not interest on anything. It’s just a tax on making money.

    So, how is it more beneficial to pay $22,000 in LTCG taxes 40 years down the road rather than get $3,000 in tax savings now even if that $3,000 is used frivolously like on a newer car or a vacation or anything else?

    The only difference between your scenario and mine is that yours pays $22,000 in taxes decades later while mine gets $3,000 up front and then pays $22,000 in taxes decades later. Am I missing something? I’m no expert by any means, so maybe a simple explanation will put me on the right track.

    • Keith Taxguy on June 24, 2019 at 7:18 am

      Dallas. my point was not to do as I say, but to think about your situation and adjust accordingly. Assumptions of lower taxes in retirement is not universal. Current tax benefits need to be weighed against future taxes paid. Also, profits and qualified dividends are taxed at a lower rate in a non-qualified account under all (maybe I should have said most) circumstances.

      I’m happy to see you running your numbers versus just doing what the crowd suggests. This alone will help you make a better financial decisions.

  19. Ron L on September 19, 2019 at 2:49 pm

    This article also is a good reason to consider retiring and using 401k or IRA money as income before start collecting your Social Security benefit and using that first 12k / 24k Federal tax automatic deduction or whatever the magic zero Federal tax rate is as your withdraw rate.
    Could you maybe write an article on this thesis?

  20. Brad Thomas on October 5, 2019 at 11:22 pm

    I hope people aren’t taking financial advice from this kind of blog.

    The math is just wrong. Leaves out the taxes you pay along with way in the taxable account (dividends, CGs, etc) and ignores the opportunity cost of the saved money being invested up front.

    As others have said, the focus on tax dollars paid instead of TOTAL MONEY EARNED is extremely misleading.

    Many others above have said this, but the author doesn’t adequately address their arguments. You get what you pay for – anyone who trusted this analysis at face value should consider getting a financial adviser to help protect their money.

    • Keith Taxguy on October 6, 2019 at 4:38 pm

      Brad, I addressed the taxes you pay along the way. Vanguard index fund, for example, throw off a dividend but to-date have side stepped capital gains distributions. The tax will be small and at a lower LTCG rate.

      There is no opportunity cost in a non-qualified account since it is not tied up inside a retirement account; it is fully accessible without penalty at any age.

      I did not focus on total money earned; I focused on how much money you have left after taxes. Depending on your facts and circumstances, the non-qualified could be the superior investment account. Once again, depending on your facts and circumstances.

      Your advice to hire a financial advisor is rather self serving. The cost of a financial advisor would further erode the value of the investment. Warren Buffett has said this repeatedly.

      No blog post should ever be taken at face value. Your circumstances are almost certainly going to be different. The best blog post puts forth an idea for readers to consider. I have done that. Now you need to take the idea presented and see if it is relevant to your, you guessed it, facts and circumstances.

      P.S. I haven’t been to Washington State for a few years, Brad. Next summer I might be heading out that way. We should take time to break bread and talk shop.

  21. Sarah on October 15, 2021 at 12:49 pm

    Can you clarify your comments on people investing the tax savings? Is your recommendation based on that sticking point? I’m still not sure if you are comparing, say, investing $19500 in a 401K with investing $19500 in a taxable account or investing [$19500 minus tax] in a taxable account. Obviously the same amount with the same growth is better taxed at capital gains rates than ordinary income rates in most cases. But I squeezed my budget pretty hard to get that 401K max so for me the loss of tax savings would mean less left over to invest in taxable accounts, and then the math gets thorny.

    • Keith Taxguy on October 15, 2021 at 2:57 pm

      Sarah, I’m comparing the same investment for the 401(k) compared to a non-qualified account. It is an apples to apples comparison. If you invest in a retirement account, how does that compare to the same investment in a non-retirement account.

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