A Complete Guide To Roth v. Pre-tax (Early Retirement Pro Tips)

Unlock the secrets to savvy retirement planning with our latest discussion on choosing between Roth and pre-tax savings. We dissect the usual tactic of leaning towards pre-tax savings when you're in a higher tax bracket—and Roth when you're expecting your income to drop—but we'll show you why this isn't just a black-and-white decision. You'll be privy to a compelling example of an individual who defies the typical investment playbook, thanks to a hefty pension. It's a deep dive into how unique personal situations can dramatically shape your retirement strategy and challenge the conventional financial wisdom.

Are you pondering an early retirement, perhaps before hitting the age of 55? We've got you covered with strategies that consider the intricacies of capital gains taxes, the 'rule of 55', and making the most of your brokerage accounts. By tuning in, you'll grasp the value of Roth accounts as tax insurance and understand how brokerage accounts can be a game-changer in funding those first years of retirement bliss, setting the stage for impactful Roth conversions. To wrap it up, we invite your most pressing questions and remind you that our insights are a springboard for your personalized planning. Remember, the road to retirement is as unique as you are, and our episode is the map you need to navigate it with confidence.

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Ari Taublieb, CFP ®, MBA is the Vice President of Root Financial Partners and a Fiduciary Financial Planner specializing in helping clients navigate the nuances of an early retirement.

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PS: Before anyone decides to move forward with our services, I want to ensure we're the best fit to help you reach your goals and I personally have the first conversation with you.

Transcript

Speaker 1: 0:00

Today's episode is a fun debate. It really won't be a debate by the end. But some people are thinking are you going to go political now for the first time? No, I'm talking about Roth versus pre-tax, how to think through it, specifically for an early retirement. Because what a lot of you are doing is the following and nothing wrong with this thinking. But you're going yeah, I'm in a higher tax bracket today, so I'm not going to do Roth, I'm going to do pre-tax, get that deduction and then in the future, when I take the income out, hopefully I'm in a lower tax bracket so I won't be taxed as heavily. Nothing wrong with that. A lot of you are going you know what. I've actually got a little bit of a gap between I take my next job, or maybe I'm just not making as much as I used to because I'm doing something that I enjoy a whole lot more, but maybe it doesn't pay as much. So you know what I'm going to do Roth, I'm going to add more dollars. I'm happily going to pay taxes now so that in the future I'm never taxed ever again. Nothing wrong with that.

Speaker 1: 0:50

But there's another level to planning, and that's what we're going to be talking about today is how do you make the decision of pre-tax versus Roth in light of an early retirement? Because level one is okay, what makes sense, pre-tax or Roth, based on where I am, future tax brackets when on retire. Level two is saying okay, what accounts should I have? That I just don't know about, and to what extent is enough in each type of account. So you might be going oh my gosh, that sounded like Portuguese, but I promise you there's validity to this. So I'm going to tell you why I want to make sure you have the right amount in each bucket, not to the you know scientific degree, but for your specific plan, because if you want to spend 5,000 month or 10,000 month, that's going to change exactly how much you have in your portfolio, because you might not need as much as your neighbor, your coworker. So I've given this basic example before, but I'm going to give it one more time before I hop into my real fun example.

Speaker 1: 1:41

Now, before I even go into either of those, I am, of course excuse me the host of the earlier time at podcast, the vice president here at root and the certified financial planner. One of my editors once said hey, do you want me to take out all of those you know, not just ums and us, because I try to keep those to a minimum. But if you say something wrong and I said no, I just think it adds authenticity. I was listening to another podcast recently and it just felt so edited. I didn't know if I was actually listening to the person or if it was like an auto-tuned version of the person. So if that is frustrating to any of you, of course, please let me know and submit a question on my website, earlytribeatpodcastcom, or say no, this is super helpful. Like. This is the type of content I want, feels real, it is authentic. So, that being said, let's hop in. What I want to do is really make sure you understand that I do not believe in cookie cutter planning. And here's an example Someone came to me and they had 100% in cash and they were 70 years old.

Speaker 1: 2:35

And another person said hey, I heard you talking about that with, like another client recently that someone was at 100% in cash. You know why would you even recommend that? And I said well, you know, to be honest, that there's more in depth planning than what you might just see. And they're like, yeah, but you said someone has 100% cash. That never makes sense. Then another client came to me and they were like hey, does it ever make sense to have 100% equities? I go, yes, and they go well, I'm sure, but not for someone like in their 50s or 60s, right, and I go, no, even that. And they're like what do you mean? So here's an example I'll give.

Speaker 1: 3:04

Real client came to me and they had about $3.5 million and that's just their investment portfolio, but they also had a pension that covered all of their needs. Now a lot of you are going, oh my gosh, like what did this person do? They're crushing it. Some people laugh at this, but I had a previous mentor. Call this the Lucky Sperm and Egg Club. Okay, so a lot of these funds were inheritance and so what was happening is this person had a pension that covered all their needs, but they also had $3.5 million in their portfolio. So this particular client was like, hey, I'm not attached emotionally to any of these stocks and it's in this type of account, like what would you do? I said I'd make it 100% equities. And they're like, oh my God, they like kind of took a step back. How could you even recommend that? I'm getting older? And we educated the client on it and they were like, oh my gosh, I see it.

Speaker 1: 3:52

What you're saying is that because my pension covers all of my needs, realistically, this three to three and a half million if it went to zero I'd still be okay I go. That's correct. It doesn't mean you're not going to emotionally, you know, lose sleep if that three and a half million goes to one million. That's not what I'm saying at all. I'm saying is you have the ability, not the requirement, the ability to take on more risk than your average early retiree because you have a pension that covers all of your needs. I would think 100% equities is a horrible recommendation if they didn't have a pension that covers all their needs. But, for example, if they have $3.5 million, they want to spend $4,000 a month. Versus someone versus someone that wants to spend $14,000 a month, the amount that they need in safe assets is going to massively differ. So you're going. Why on earth are you explaining this? I go.

Speaker 1: 4:40

Here's why, when you're thinking about an early retirement, beyond thinking about do I have enough, what I want to do in retirement, all important stuff I need to make sure that you're not leaving anything on the table unnecessarily, especially from a tax perspective. So a lot of you are going hey, I thought you were going to just tell me am I going to do Roth, am I going to do pre-tax, like, give me the answer. And unfortunately I'm not going to. And I'm going to tell you why. I'm going to give you an answer. Don't get me wrong. You're going to get an answer. In fact, I think it's going to be more than what you were expecting. But here's what I mean by that.

Speaker 1: 5:09

Someone once said Ari, tell me my Roth conversion strategy when I'm in year 2030. I said no, they're like Ari, I'm your client, I'm paying you a lot of money. Why won't you do it? I go yeah, I won't do it. They're like what do you mean? I go here's what I mean. What I don't want to do is essentially lay out this beautiful Roth conversion strategy where you move money from your IRA to your Roth IRA in the years where your income is low. They're like what do you mean? That sounds great, that's what you talk about. Isn't that what I should do? And here's what I'll tell the client. So I'll say well, I know tax brackets are changing in 2026 and we want to do these Roth conversions, and so here's what the math says.

Speaker 1: 5:44

The financial answer is absolutely do a Roth conversion, do it in these years, take advantage of a healthcare subsidy for a portion, then switch to Roth conversions and then I go. Wait a second, no, we don't want to do that. They're like I was following. Well, why are you taking me off the path I go. Here's why. What I know is I know your health, I know your energy, I know what you shared with me in our first meeting, which is you want to sail around the world with your spouse. I would rather you take $80,000, go do that and then do Roth conversions for the rest of your life. Once you tell me that, you say you don't want to travel as much, and at that point, yeah, your Roth conversions were not optimized on paper, but your life was, and I don't want you to be 90, going. We did great Roth conversions, but I actually didn't take the trip when I had my energy and my health and when that money was actually worth more.

Speaker 1: 6:31

So my job, as I see it, is to essentially say here's the financial answer do a Roth conversion, do tax gain harvesting, do all these cool tax techniques. After you determine what you want in life. Most people do the opposite Is they go. You know what for my financial strategy, it makes most sense to actually retire in four years, not in three years, because I'll have X amount of more dollars. I go, that's true. But how often are you just gonna keep pushing those goalposts back to say, yep, I'll just retire in one more year. Yeah, two more years. You have one more bonus. Then I'm done. Too many people do that and I'm not gonna let you, because I am the meanest early retirement planner. I don't let anyone retire too early, but I also don't want you to retire too late, where you have tons of money and you go why didn't I retire earlier? So let's take this to the next level here. So what I wanna do now is absolutely make sure you understand how I think through Roth and pre-tax.

Speaker 1: 7:20

So let's assume someone comes to me and they have actually I built out a very simple example here. I was gonna illustrate it on the fly, but I built this one out for you, so I think this could be helpful. Let's assume that you have $100,000, super easy. You have $100,000 that you've put into a Roth and you're in the 35% federal tax bracket. Now some of you go. Well, wait a second. That's just not possible. Isn't the maximum like 7,000? Or wait, can I do 8,000? I'm over age 50? Just humor me for a second. So let's assume you have 100,000, you put it into Roth and you're in the 35% tax bracket. Your taxes would be 35,000, meaning you're in the 35% tax bracket. You could have done anything with these dollars. $100,000 is going in to your Roth IRA, just an example.

Speaker 1: 8:03

Now let's say that Roth grew to 400,000. What happened is you put in 100, in the 35% tax bracket. It's now worth 400,000. 300,000 of that is tax-free earnings, tax-free growth. Pretty simple so far. Now let's look at what was the total tax you just paid. Okay, so you put in $100,000, you paid $35,000 in taxes. Now it's worth 400,000. You paid $35,000, pretty simple.

Speaker 1: 8:28

Now let's take the same exact example, because too many people overcomplicate this and start going crazy. Now let's do the same exact thing. That was super simple with traditional. Now let's assume that you are in the 35% tax bracket today. Nothing's changed at all. But when you're in retirement, you're gonna be in the 22% bracket because maybe there's pension or rental income or something like that. And when you start pulling out the money, you're gonna be in the 22% bracket. So let's go through my same example. You now decide that you're gonna put the full $100,000 into the traditional, so not into the Roth, but into the traditional. Now you're gonna owe taxes on that full $100,000, if you were to take it out in the future and you're in the 22% bracket. But let's use the same example.

Speaker 1: 9:15

Compare apples to apples, not apples to oranges. In example one, we put in $100,000, grew to 400, 300 of growth. Let's do the same thing here. You put in $100, grew to 400,000. Now all you have is $400,000, that is in a Roth IRA that you paid taxes on early on, 35,000 bucks worth, and now it's worth 400,000. Now that's part A. Part B is you now have $400,000. You put in 100, but it always growing tax deferred let's call it in your 401k, just an example. And now you have $400,000. And in the future you're gonna owe 22% taxes on the $400,000. That's an $88,000 tax bill. So in example one, you had a $35,000 tax bill. In example two, you have an $88,000 tax bill.

Speaker 1: 10:00

So I'll tell people well, isn't that a no-brainer? And then people go well, I see your logic here, but wait a second. Like shouldn't I vary this Like certain months or years you know I'm in this tax bracket and other years I'm in this tax bracket. I go look at it really simply.

Speaker 1: 10:15

The majority of you guys are high earners. You're probably in your early 40s, late 40s, early 50s, late 50s, early 60s. That's the majority of you. You're reaching out. Go hey, I'm in a high tax bracket. In the future I'm gonna be in a lower bracket. What should I do?

Speaker 1: 10:29

And so a lot of you are going oh, I see Ari's point here. He's gonna say that maybe I should do Roth because, even though I'm in a high tax bracket, the money grows tax-free forever. And sometimes the answer is yes. Other times I say you know what? No, you're in a high tax bracket, I wanna make sure that you're adding dollars to your pre-tax account. You get that deduction today.

Speaker 1: 10:49

And so people go okay, I get it, but like, tell me the answer. Like I'm not more clear at this point, I go here's the answer. The answer is it depends how much you have in your pre-tax balance already. Because if you have a $2 million in a 401k and you're adding more dollars, even though you're in a high tax bracket, yes, you're getting a deduction for it, but at the same time you're just adding to this future tax bomb. That's gonna happen Now.

Speaker 1: 11:11

If you're willing to do Roth conversions and be very strategic in your retirement and you're retiring it, for example, age 60, and go well, I'm happy to add more dollars and get a deduction up here when I'm in the 35% bracket so that I can do Roth conversions once I'm in the 20% bracket, or 22 or 15 or whatever it is Well then at that point it's almost a no-brainer. We call that tax arbitrage Get a deduction at 35%, convert it at 22%. But too many people simply look at that versus saying, okay, what's the overall tax allocation which very few people talk about of my whole strategy? So understand, first and foremost, where are your assets? Is it 50% pre-tax 50% Roth? Is it 75% pre-tax 25% Roth? Is it 100% pre-tax 0% Roth? And so if you have 100% pre-tax, even though you're in a high tax bracket, oftentimes I'll say why don't you do Roth? Because you need some more diversification, not a crazy amount, but start moving a portion to that Roth 401k. Other times I'll say you know what I'd rather you do instead of adding dollars there, I'd rather you add money to a brokerage account. And people go whoa, whoa, whoa. I thought this was like Roth versus pre-tax, and what should I do? And I go oh yeah, nothing wrong with that at all.

Speaker 1: 12:22

But the next level of planning is essentially going what if you retire at 57 or 56 or 55? Or, let's take it, 53. What if you retire at 53 or 54? Well, now you can't use, maybe, the rule of 55 to access a 401k. You maybe can't use some of these other rules, and so what you might wanna do is go well, yeah, I know, I can add dollars to my Roth or my pre-tax, but you know what? I'm gonna add more dollars to my brokerage account, because here's the real power of doing that. I call it the superhero account, which is you add dollars to your traditional brokerage account or your taxable or your joint or your individual. They all mean excuse me, they all mean the same thing.

Speaker 1: 12:58

The government makes it as confusing as possible to try to understand what the differences are, but the benefit of doing so is it keeps your income really low. So let's assume that you were to retire at 60 and you take money out from your IRA and you wanna do Roth conversions. If you take out 100,000 from your IRA, the government just says hey, you know you didn't work, but you made $100,000. That's all taxable Now from your brokerage account. It doesn't work that way.

Speaker 1: 13:25

You pay what are called capital gains versus ordinary income as long as you hold it for over a year. So if you bought Apple stock, for example, for $1,000, now it's worth $100,000, that's a $99,000 gain that you're not gonna be paying taxes on it 22 and potentially 25 and 28% taxes. As long as you've held it for over a year. You're gonna be paying taxes at capital gains, which is way lower, and capital gains taxes don't increase your ordinary income brackets. Which means, quite simply, what happens is you can keep adding. You know you could sell a home, for example, for $500,000 and you could have ordinary income taxes of zero. That doesn't increase your ordinary income, it's simply increasing your adjusted gross income. Now it becomes really complicated really quickly.

Speaker 1: 14:10

But what I want you all to do is essentially look at your assets today. What portion is Roth? What portion is pre-tax? Should we add some brokerage account dollars to be able to add some more flexibility? Now I'm gonna add one more layer to this, which you're going oh my gosh, I'm barely following at this point.

Speaker 1: 14:25

Most of your podcasts are clear, but this, for the first time, feels like one that's almost starting to go over my head. I promise here's what I'm gonna do for you. Break it down. What I want you to do whenever you're in doubt is, if your cash flow allows for it, I want you to add more dollars to Roth and you're like no, but I am in a high tax bracket. I personally believe that Roth the way I want you to frame it is just tax insurance. I'm not saying in the future you're gonna be in a lower tax bracket. I don't know if you're gonna be in a higher tax bracket, but what you're doing is saying I'm happy to pay taxes where I am to never pay taxes ever again. Because if you're putting those dollars in Roth and it grows and grows and grows, all that compounding that's occurring is tax free forever.

Speaker 1: 15:04

So doing a Roth conversion if you have a healthy amount in your pre-tax account, can be amazing. That's my cauliflower example that I tell all of you about, and if you haven't seen that, go ahead and check that out on YouTube, where I talk about my cauliflower examples. I have other podcasts episodes where I go through it in more detail as well. But what I wanna make sure you are all doing is going okay. When do I just before even going to Roth versus pre-taxes, when do I wanna retire? Is it five years, 10 years from now? How old will you be?

Speaker 1: 15:28

Because if you're gonna be 60, 62, 63, the truth is, of course you could pull from your IRA, but does that make the most sense? Of course you could pull from your Roth IRA, but does that make the most sense? More often than not, if you have a brokerage account and helps keep your income lower to be able to do more Roth conversions, which are gonna be way, way, way more effective than kind of quantifying the outcome of adding more dollars, roth or pre-tax If you were to add essentially $10,000 to a brokerage account and then let that grow to 100,000 and use that for the first few years of retirement maybe one year or two years and keep your income low to do Roth conversions, you can now move a ton of money from your IRA your Roth IRA 40, 50, 60, 70, 80, 100,000 plus dollars and it's gonna be way more effective than you trying to debate. Should I add this 30,000 bucks to my 401k Roth or pre-tax? Yes, it's gonna matter, but it's not near as effective. It's almost like debating whether or not you should buy coffee every morning or essentially taking way more time to research. Should I buy that right car of a difference of five or 10 or 15 or $20,000. So that's one way to think about it. The next way is essentially to go wait a second. What about some big expenses? Like I'm thinking about retiring early and I want to retire but I've got to do this renovation, or I'm still subsidizing my parents, or I'm thinking about buying this thing for my home.

Speaker 1: 16:44

What I'll often recommend is say, hey, if you have enough stocked away and Roth and pre-tax and brokerage, like I almost say, don't save anymore. Not because you couldn't of course you could and naturally you probably are where you are because you're a good saver but I don't want you to over save, and a lot of you do that. I would rather you actually under save once you've got to a position where you have plenty of assets. I'd rather you actually go spend more money and say you know what. I'm gonna make the renovation I'm not gonna do Roth or pre-tax maybe, I'm just gonna do the full match, but anything after that I'm not gonna do.

Speaker 1: 17:16

And that's a common recommendation, meaning all, oftentimes say, hey, what's your 401k match? And they'll say 3% or 5%. I say, great, I want you to do the 5% full match and normally you're gonna max out your 401k. But don't do that anymore. You already have such a healthy amount in your pre-tax account. I want you to take that other 20,000 bucks, put it to a brokerage account and I wanna use that in the first few years of an early retirement. Other times they say, no, you've already got a brokerage account, it's got healthy gains. I'd rather you go actually practice retirement. So I'm gonna almost quasi force you to go spend it on a big trip. It's gonna feel weird because you've never taken a trip like this, but I want you to do it to even understand is that something you actually wanna do in retirement? Because you might find it's not and that $20,000 was an amazing test so that you can gauge actually how much travel you want to do in retirement.

Speaker 1: 18:03

So it's like what are the next level, like pro strategies here versus simply Roth and pre-tax, which is what everyone does and there's nothing wrong with that. You wanna make the right decision, but it has to be made in context of your plan. When in doubt and I have some really high earners that work with me. They're even doing Roth Going. Hey, I don't know what's gonna happen in the future. I just wanna be really intentional about am I potentially leaving money on the table and if you have 100,000, 200,000, 400,000, if you have a lot of dollars that's growing tax-free on your Roth IRA. It's powerful stuff. So wanna make sure you're all thinking through that effectively.

Speaker 1: 18:36

Now some of you are going, oh my gosh, like, are you married to Roth IRAs? You love Roth IRAs. I don't love them. What I love is a lot of the features are applicable to you guys. Which is a Roth IRA? Your heirs are not paying taxes on that. You already paid tax on that. So, god forbid, something happens, you're now not adding a tax burden to them. Additionally, this is not gonna impact what are called your Irma surcharges in the future. So in the future, you're gonna have a new tax bracket once you're 65 and there's Medicare premiums and dependent on your income is your Medicare premiums are gonna shoot up every single month. They're called Irma surcharges, i-r-m-a-a. Your Roth IRAs don't count towards that, so it really is gonna be helpful for you.

Speaker 1: 19:16

In addition to that, roth IRAs don't have required minimum distributions. So if you're worried about RMDs, yeah, you better believe we're gonna be considering Roth conversions and some of these strategies so that you do not have to get subject with RMDs that are excessive. Too many people say, oh my gosh, require distributions. That's horrible. That's not what I'm saying. What I'm saying is I want you to get those RMDs to a manageable level. I don't want you to overpay in taxes, and I've seen this before where people do too much in Roth conversions and then come to us and expect us to fix the issue.

Speaker 1: 19:45

It's better to not do any conversions. Make sure you do them properly and essentially go okay over time, based on how markets are moving. What are we gonna do? So I always break it down for people in the following way I'll say, hey, there's three numbers you need to know your NBB, your NBD and your TB and you're like all right, are you just making this stuff up? I go yeah, but it resonates, so trust me on this.

Speaker 1: 20:05

The first one is NBB no-brainer bracket. What that means is no matter what, as long as you're on planet Earth, and you're with me on Earth where you're filling up this tax bracket, it's a no-brainer. That's like, hey, very, very low-hanging fruit. If we don't do that, I just couldn't even work with you. I couldn't sleep at night. It's a no-brainer. Then you have what's called your no-brainer dynamic bracket, your NBD, which is, hey, markets oftentimes are actually fluctuating throughout the year and, as opposed to just sitting on our hands and, when markets go down, just saying I'm gonna be a good long-term investor, let's be proactive and start doing more of these conversions. And then there's finally your TB. That's your tax bomb. That's saying what if we don't do any of this at all, you just do nothing I talk about? In the future, you're gonna have your TB, which is your tax bomb. What we don't wanna do is simply say, yeah, I'll worry about taxes later, because once it comes, it comes and it doesn't stop Meaning those required distributions. They come and they're just gonna keep coming. So you wanna be really efficient and effective as to how you plan for all of these moving pieces.

Speaker 1: 21:05

Now, this was a lot I recognize. And so that decision of should I do Roth? Should I do pre-tax how do I think through it Really understand. Does a brokerage account make sense for your situation? Are you considering an early retirement? Do you already have a lot in your pre-tax account. If so, even though you're in a high tax bracket, maybe consider Roth. Maybe you're going oh my gosh, you know. This just further validated the fact that I'm gonna do amazing Roth conversions and I'm gonna still add dollars pre-tax and then, in a year from now, I'm gonna retire and do these Roth conversions and all these cool tax techniques and that's what I'm gonna do Great, whatever. This really helps you understand. That's why I do this.

Speaker 1: 21:38

So I know this is a tax heavier episode, but hopefully really helpful for you guys to start to understand. Okay, based on the timing of when I retire, how much I want to spend, what I want to do. Too many people just do the Roth versus pre-tax, versus the. Okay, should I actually do neither and practice spending in retirement and almost saying what do I want to do, really gauging what would make sense for me? Because I promise you are not going to look back and go. I'm so glad my average return was 8.326497%. You're gonna say I'm so glad I retired earlier, spent more time with my family, was able to make my spouse stress a whole lot less and I was traveling and, yes, I did great conversion so my kids won't have to pay as much. It's a legacy play, but ultimately I'm in an awesome spot, so hopefully this episode was helpful.

Speaker 1: 22:20

Once again, I know I'm not going to get to work with all of you, but if any of you are interested in working with us, please do, of course, apply to work with us. We bring on a limited number of people every single month, but over even that, I want you guys to keep getting helpful information. So if you have something you want me to make, an episode on earlyretirementpodcastcom is where you can submit your question, and I kindly ask that you do leave a review if this podcast has been even remotely helpful. Helps more people find the show. Love you guys.

Speaker 1: 22:47

Thank you for listening to another episode of the early retirement show. If you have a question that you want answered in a future episode, you can always go to my website, earlyretirementpodcastcom. That's early retirementpodcastcom, and you can go ahead and submit a question that I'll look to answer in a future episode. Thank you all for listening. Please do rate it, review it and share it with someone who you think would benefit from this information. If there's anyone out there that you know, I certainly appreciate it and I will see you all each week. Hey guys, it's me again. Please be smart about this. Nothing in this podcast should be construed as financial, tax or legal advice. Consult with your tax preparer or financial advisor before taking any action. This podcast is for informational purposes only.