24 y/o and making $55k - should I go traditional or Roth 401k?

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abump96
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24 y/o and making $55k - should I go traditional or Roth 401k?

Post by abump96 »

I currently contribute $800 per paycheck to a traditional 401k through my company. This will put me right near the max yearly contribution limit by the end of the year. I also have a Roth IRA that I max.

Once I knock off $15k of taxable income to get that portion out of the 22% tax bracket, should I switch my contributions (the ~$4500 I’ll have left to contribute before hitting the limit) to Roth contributions?

My reasoning is that it’s worth it to contribute to the traditional until I get out the 22% bracket, but once I get to the 10% bracket, I’m probably gaining more by eating those taxes and not being taxed later thanks to Roth. Or is it worth it even sitting with about $15k that’ll be taxed at 22% to go Roth for all $19500 of my contributions (obviously won’t be able to do that this year now that we’re in May, but point stands..).

Larger question is, while in my 20s and at this salary, is it just better just to go Roth all the way since this is money that will be growing for 40+ years. Is Traditional only better in the super high tax brackets?
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by RickBoglehead »

Roth IRA and Roth 401k.
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lakpr
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by lakpr »

Do you remember the often repeated story of two investors, one of whom starts early and contributes for only 10 years, the other starts at the end of 10 years but contributes the same amount for 20 years .... and guess who wins out at the end of that 30 year period?

Assuming an identical investment of $10k per year, and an identical 7% return.

Investor A: periodic investment of $10k for 10 years, 7% annualized return, end value at 10 years = $138k. No further contributions after 10 years, 30-year end balance = $534.6k

Investor B: starts late, waits 10 years to start investing, but invests same $10k per year for 20 years (twice as long). Final balance = $409k.

Vary the numbers to your heart's content, but the final conclusion remains the same. Starting early gives you a GREAT advantage.

========================

Why I repeat this story? because I want you to be Investor A in the early phase of your career. Go Roth all the way for 10 years. Then become Investor B when you are likely to be in your peak earning years. You need tax deferral much more then than you do now. The eventual result would be that you will end up with near about 50:50 balance between pre-tax and Roth assets, a great place to be in.
Makefile
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by Makefile »

abump96 wrote: Thu May 06, 2021 8:10 pm I currently contribute $800 per paycheck to a traditional 401k through my company. This will put me right near the max yearly contribution limit by the end of the year. I also have a Roth IRA that I max.

Once I knock off $15k of taxable income to get that portion out of the 22% tax bracket, should I switch my contributions (the ~$4500 I’ll have left to contribute before hitting the limit) to Roth contributions?

My reasoning is that it’s worth it to contribute to the traditional until I get out the 22% bracket, but once I get to the 10% bracket, I’m probably gaining more by eating those taxes and not being taxed later thanks to Roth. Or is it worth it even sitting with about $15k that’ll be taxed at 22% to go Roth for all $19500 of my contributions (obviously won’t be able to do that this year now that we’re in May, but point stands..).

Larger question is, while in my 20s and at this salary, is it just better just to go Roth all the way since this is money that will be growing for 40+ years. Is Traditional only better in the super high tax brackets?
It's a tough question because the ideal answer depends on predicting both investment returns and future tax rates.

On this forum there are a disproportionate number of members who have a pension in addition to their IRAs/employer retirement plans, and/or have a large balance in the plan, such that their required minimum distributions are so large as to be a tax nuisance. So with a time machine they would have much preferred to go much heavier on Roth.

On the other hand, you want at least enough Traditional to take advantage of the standard deduction and 10%/12% brackets while in retirement.

Given that you are also doing a maximum Roth IRA, Traditional 401(k) down to the bottom of the 22% bracket doesn't seem bad at all.

Another wildcard is that there is a Saver's Credit having a discontinuity at a $32,500 AGI, where if you can manage to get down to that level, you may be able to get a free $2000 tax credit, which for you, might tilt things in heavily favor of Traditional...

What is are the income prospects for your career? If you expect to track $55,000 plus inflation and perhaps a bit more, that pushes toward Traditional; if it might be $120,000 in three years, that pushes toward Roth.

Can you still afford to max out both the 401(k) and IRA if you go to all-Roth?
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by Trader Joe »

"24 y/o and making $55k - should I go traditional or Roth 401k?"

Go with Roth's (401k and IRA).
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Lee_WSP
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by Lee_WSP »

Based on income statistics, you are much more likely to earn more later in life which means Roth is better.
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Free to Choose
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by Free to Choose »

Remember you want to subtract your Standard Deduction, presumably, from your $55k income: $55-$12.55k = $42.45K. You may also have other deductions that lower your Taxable Income or credits.

Also, consider any state income tax.

Use some calculators to help you understand the math. Look in the Boglehead wikis

The short answer is you will probably benefit more from the Roth 401k.
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abump96
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by abump96 »

I really appreciate the responses so far! My only confusion is that some people are saying Roth is best because I’ll likely be in a higher tax bracket than where I am now when 60+/retired and pulling from my retirement accounts. However, my assumption is I won’t start pulling from those accounts until I’m completely done working and therefore have no income and therefore are in the lowest tax bracket - which for long term capital gains is 0% - effectively making my traditional contributions equivalent to Roth contributions.

Is the point I’m missing that some people choose to start pulling from their retirement accounts while they’re still working and therefore might be in a higher tax bracket?
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Watty
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by Watty »

There is a wiki on this choice if you have not seen it.

https://www.bogleheads.org/wiki/Traditional_versus_Roth

There are some important things that you did not mention.

1) What are your state taxes? One complication is that you could end up retiring in a different state with higher or lower state taxes.

2) Your marital taxes. It sounds like you are single now and filing tax returns in the higher single tax brackets but you could be married when you are retired and filing tax returns in lower joint tax brackets. At least under the current tax laws an over 65 couple can have over $100K in taxable income and still be in the 12% federal tax bracket.

3) What are your other financial goals? The reason I ask is if you are also doing something like saving up a down payment to buy a house some day(There is no hurry!) then contributing money to a deductible IRA would allow you to save for some other goal. For example in the 12% federal tax bracket and you contribute $1000 to a deductible IRA then you could also put the $120 in tax savings into a house down payment fund.

With so long until you retire trying to mathematically calculate which is best is fools errand since so much will change by the time you retire. Not only could tax laws change radically but your life could, and likely will, have unexpected twists and turns.

You also need to be careful since you are a long way from being in a high retirement tax bracket.
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Brianmcg321
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by Brianmcg321 »

Roth.
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LittleMaggieMae
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by LittleMaggieMae »

I think you need to consider the career path/income level you feel your job will follow. There are lots of good income jobs that just steadily increase over one's life time and then there are the jobs that big jump in income every time you switch jobs or move up the corporate ladder.
Do you foresee the possibility of a pension at some point (as in you may transition to an employer that offers a solid pension)?
If you foresee earning 100K or more within 5 or 6 years OR are working towards a job with a pension - I'd probably go Roth all the way.

Something else to consider - any money you contribute to your Roth can eventually take over some "Emergency Fund" duties. Your Roth contributions would be the EF money you use last in case of an "emergency" - which in most cases is long term job loss. Read up on the rules for withdrawing Roth contributions. If you contribute 6K for the next 4 years - you've got a 24K in your EF - and its working for you - invest it. If you also accumulate 3 to 4 months of expenses (or 2 months net income whatever else makes you feel comfortable) in some liquid "cash" type account - you can probably scratch "build EF" off your list of things to accomplish. Every year you add to your Roth builds your EF. Again, this works best if you have a stable steady job and job loss isn't always looming on the horizon.

You don't mention any debt - consumer debt or student loans. If you have debt - I would figure out how to have it paid off by some date that lets you keep saving 15% to retirement while paying down the debt. I know that's not Dave Ramsey advice - but then you aren't his target audience - you've got a lot of disposable income that you can allocate to savings... you don't have to "find" your debt paydown money - you have it.

I don't think there's a wrong path or answer for which way you go...being able to front loading your retirement accounts puts you way ahead. Even if you cut back to 15% of Gross Income in a few years (your income doesn't keep climbing quickly and life happens - significant other, kid(s), house) you are still ahead.
Last edited by LittleMaggieMae on Thu May 06, 2021 9:54 pm, edited 1 time in total.
averagedude
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by averagedude »

You asking this question and being on this forum at age 24 would give me reason to recommend that you go the ROTH route. Your future investment accounts will more than likely be way above the average person when you are in your late sixties. You will be happy having the tax diversification of tax free and tax deferred money. To me, this is a no brainer. Keep in mind you will still have traditional money due to the company match.
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by LittleMaggieMae »

Don't forget - you aren't committed for the rest of your life to the decisions on how you will allocate all your future income money among the tax advantaged accounts you have access to today. Remember to review each year and make changes (or not) as circumstances change.

That's the biggest mistake I made - I did a set it and forget it for 15 years while my income was going up - during those years it would have been better if I had funded a Roth. And if I would have increased my 401K contribution %. It's not a catastrophic mistake but perhaps if I had been more interested in how my money was working for me - I might have made contributed some to a Roth (I had good intentions and opened one and then did nothing with it for 8 years - even though could have easily contributed to it).
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by Doc7 »

abump96 wrote: Thu May 06, 2021 9:10 pm I really appreciate the responses so far! My only confusion is that some people are saying Roth is best because I’ll likely be in a higher tax bracket than where I am now when 60+/retired and pulling from my retirement accounts. However, my assumption is I won’t start pulling from those accounts until I’m completely done working and therefore have no income and therefore are in the lowest tax bracket - which for long term capital gains is 0% - effectively making my traditional contributions equivalent to Roth contributions.

Is the point I’m missing that some people choose to start pulling from their retirement accounts while they’re still working and therefore might be in a higher tax bracket?

Your income will be the amount you pull from your traditional 401k, for some, taxed quite heavily (large accounts and RMDs that they have to withdraw later in life) not $0 though some tax strategies get you there.

Also - 401k distribution is taxed at income rates, capital gains, long term or otherwise, have nothing to do with them.
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by epargnant »

abump96 wrote: Thu May 06, 2021 9:10 pm I really appreciate the responses so far! My only confusion is that some people are saying Roth is best because I’ll likely be in a higher tax bracket than where I am now when 60+/retired and pulling from my retirement accounts. However, my assumption is I won’t start pulling from those accounts until I’m completely done working and therefore have no income and therefore are in the lowest tax bracket - which for long term capital gains is 0% - effectively making my traditional contributions equivalent to Roth contributions.

Is the point I’m missing that some people choose to start pulling from their retirement accounts while they’re still working and therefore might be in a higher tax bracket?
When you eventually withdraw from a traditional IRA or 401K, you pay regular income tax on the entire withdrawal, not just capital gains.
britcoal
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by britcoal »

I would do this (if possible):

55k - 12,550 (std deduction) = $42,450.

Put at least $10k into the traditional 401k to get your MAGI below the $33k and you will get the 10% savers tax credit (if you could get your MAGI down below $21,500 you could get a 20% tax credit, but that probably isn't possible - you need money to live on!).

Put the rest in your ROTH 401k and/or ROTH IRA.

At that point you'd be in the 12% tax bracket and also be getting tax credits.

Also, if you have High Deductible Healthcare plan option at work that would allow you to also put money in an HSA - which is triple tax-advantaged.. and you're young so likely have low or no healthcare costs other than your premiums.. Though you're probably locked into your employers healthcare so you may need to wait for the next open-enrollment period to switch plans.

Also, as per the above, money put into traditional 401ks and IRAs will be taxed as income, not as capital gains.. something you definitely want to be aware of. Money in a ROTH at retirement comes out tax free, so the more you have in ROTH the more you can limit withdrawals from traditional accounts to help you stay in low tax brackets. Example:

If you were retired today, you could take out $53k for the year from traditional accounts and remain in the 12% tax bracket.. then take any more money you need out of ROTH tax free. The 12% bracket tops out at $40,550 + std deduction of $12,550 = ~$53k.
eyemgh
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by eyemgh »

epargnant wrote: Thu May 06, 2021 10:13 pm
abump96 wrote: Thu May 06, 2021 9:10 pm I really appreciate the responses so far! My only confusion is that some people are saying Roth is best because I’ll likely be in a higher tax bracket than where I am now when 60+/retired and pulling from my retirement accounts. However, my assumption is I won’t start pulling from those accounts until I’m completely done working and therefore have no income and therefore are in the lowest tax bracket - which for long term capital gains is 0% - effectively making my traditional contributions equivalent to Roth contributions.

Is the point I’m missing that some people choose to start pulling from their retirement accounts while they’re still working and therefore might be in a higher tax bracket?
When you eventually withdraw from a traditional IRA or 401K, you pay regular income tax on the entire withdrawal, not just capital gains.
This was probably just misspoked/mistyped, but 401k withdrawals are treated as income. Gains are not taxed. There is no capital gains in a 401k.

The post just above is the perfect summation.

You probably will make more than $55k, but it's nice to be in a position to play the system and fairly pay the least tax possible.
lucha
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by lucha »

Makefile wrote: Thu May 06, 2021 8:22 pm
Another wildcard is that there is a Saver's Credit having a discontinuity at a $32,500 AGI, where if you can manage to get down to that level, you may be able to get a free $2000 tax credit, which for you, might tilt things in heavily favor of Traditional...
Would it be possible to explain this in more detail? What is the Saver's Credit?
I am in a similar position as OP where I have income that depending on where I save a portion of it will change my tax bracket. Prefer Roth of course as much as I can and now considering doing a conversion from solo 401k to Roth 401k in future years if/when my income situation changes (I'm self-employed so it does fluctuate as well as I have many varying deductions from year to year)
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by lakpr »

lucha wrote: Fri May 07, 2021 12:32 am
Makefile wrote: Thu May 06, 2021 8:22 pm
Another wildcard is that there is a Saver's Credit having a discontinuity at a $32,500 AGI, where if you can manage to get down to that level, you may be able to get a free $2000 tax credit, which for you, might tilt things in heavily favor of Traditional...
Would it be possible to explain this in more detail? What is the Saver's Credit?
I am in a similar position as OP where I have income that depending on where I save a portion of it will change my tax bracket. Prefer Roth of course as much as I can and now considering doing a conversion from solo 401k to Roth 401k in future years if/when my income situation changes (I'm self-employed so it does fluctuate as well as I have many varying deductions from year to year)
https://www.irs.gov/retirement-plans/pl ... ers-credit

Basically, if your adjusted gross income is less than a certain limit, the government kicks in a small incentive. It is either $200 or $400 or $10000 (10% or 20% or 50% of max amount of $2000 per person).

For Single filers, that threshold is at $33,000 AGI (that $32,500 figure is for 2020, for 2021 it is $500 higher) for 10% credit.

Traditional pretax 401k contributions reduce the AGI.

In my opinion, $200 is not a big enough incentive to overcome years worth of tax free growth. I would strongly recommend Roth 401k. The higher incentives of $400 or $1000 require much lower AGI, so even if the OP (and not sure about your income) makes the max $19,500 pretax contribution to 401k, the AGI would not meet the lower threshold. Max the OP could get is only $200.
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JoeRetire
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by JoeRetire »

abump96 wrote: Thu May 06, 2021 8:10 pm Larger question is, while in my 20s and at this salary, is it just better just to go Roth all the way since this is money that will be growing for 40+ years. Is Traditional only better in the super high tax brackets?
It has nothing to do with "growing for 40+ years".

If you think your tax brackets in retirement will be lower than your current tax bracket, then defer your taxes by using traditional retirement accounts.
If you think your tax brackets in retirement will be higher, then pay the taxes now and use Roth accounts.
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reln
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by reln »

abump96 wrote: Thu May 06, 2021 8:10 pm I currently contribute $800 per paycheck to a traditional 401k through my company. This will put me right near the max yearly contribution limit by the end of the year. I also have a Roth IRA that I max.

Once I knock off $15k of taxable income to get that portion out of the 22% tax bracket, should I switch my contributions (the ~$4500 I’ll have left to contribute before hitting the limit) to Roth contributions?

My reasoning is that it’s worth it to contribute to the traditional until I get out the 22% bracket, but once I get to the 10% bracket, I’m probably gaining more by eating those taxes and not being taxed later thanks to Roth. Or is it worth it even sitting with about $15k that’ll be taxed at 22% to go Roth for all $19500 of my contributions (obviously won’t be able to do that this year now that we’re in May, but point stands..).

Larger question is, while in my 20s and at this salary, is it just better just to go Roth all the way since this is money that will be growing for 40+ years. Is Traditional only better in the super high tax brackets?
Go Roth 100%. Convert your current trad 401k assets to Roth 401k over the next few years (before the current lower tax rates revert to the higher tax rates).

Don't think about trad 401k until you're much older making a lot more money.
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teen persuasion
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by teen persuasion »

abump96 wrote: Thu May 06, 2021 8:10 pm I currently contribute $800 per paycheck to a traditional 401k through my company. This will put me right near the max yearly contribution limit by the end of the year. I also have a Roth IRA that I max.

Once I knock off $15k of taxable income to get that portion out of the 22% tax bracket, should I switch my contributions (the ~$4500 I’ll have left to contribute before hitting the limit) to Roth contributions?

My reasoning is that it’s worth it to contribute to the traditional until I get out the 22% bracket, but once I get to the 10% bracket, I’m probably gaining more by eating those taxes and not being taxed later thanks to Roth. Or is it worth it even sitting with about $15k that’ll be taxed at 22% to go Roth for all $19500 of my contributions (obviously won’t be able to do that this year now that we’re in May, but point stands..).

Larger question is, while in my 20s and at this salary, is it just better just to go Roth all the way since this is money that will be growing for 40+ years. Is Traditional only better in the super high tax brackets?
First off, you've forgotten the standard deduction - that *nearly* gets you to the bottom of the 22% bracket. If you make any health insurance contributions thru payroll, or HSA contributions thru payroll, those also reduce your taxable income. So you need at most a few $thousand in traditional to get you into the 12% bracket.

If there's any employer match, that will always be traditional, so even going mostly or all Roth for your contributions, you will have *some* traditional balance to create RMDs in the future.

Any withdrawal or conversion from traditional is taxed as ordinary income (just like wages), it doesn't get the lower LTCG rates that taxable accounts do. If those withdrawals/conversions are relatively small, they may fit within the standard deduction and be tax free. But if you are also collecting SS at the time, they can rapidly increase the amount of your SS that is subject to taxes - SS taxation is quirky. So lower future RMDs (on top of SS) is better than higher.

Run the numbers on what it will cost you to contribute trad vs Roth. A quick & dirty first pass looks like $2550-ish vs $5150-ish, maybe $200 less on the first if you get the Saver's credit. What about state tax? So can you cover your expenses after setting aside $19,500 + $6k + federal taxes + state taxes + FICA + ?

As others have mentioned, tax brackets are low right now, and scheduled to revert to higher rates in a few years. Front loading Roth contributions at lower rates may be advantageous; then you are free to shift more to traditional in future years to grab the tax deferral at higher rates.
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BolderBoy
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by BolderBoy »

abump96 wrote: Thu May 06, 2021 8:10 pmLarger question is, while in my 20s and at this salary, is it just better just to go Roth all the way since this is money that will be growing for 40+ years.
Yes.
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MittensMoney
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by MittensMoney »

I'd suggest maxing out ROTH space early since the capital gains will be substantial over such a long timeframe, and your eligibility to contribute to that specific space may end as you gain momentum professionally.
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FiveK
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Re: 24 y/o and making $55k - should I go traditional or Roth 401k?

Post by FiveK »

abump96 wrote: Thu May 06, 2021 8:10 pm My reasoning is that it’s worth it to contribute to the traditional until I get out the 22% bracket, but once I get to the [12]% bracket, I’m probably gaining more by eating those taxes and not being taxed later thanks to Roth.
Knowing nothing else about your situation, that seems pretty good reasoning.

However, generic rules of thumb in this area have many exceptions, so you may want to do your own rough guessing. See the wiki article Watty mentioned, particularly the Estimating future marginal tax rate section. As others have said, many things can happen in the next 30-50 years so don't agonize over this, but a little self-study can help you make some reasonable guesses.
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