Is Roth Better than Pre-tax?

We unpack Roth vs pretax with clear rules of thumb, why Roth is a tax code not an account, and how RMDs can create a tax spike you don’t need. A real case study shows how targeted Roth conversions and a 50-50 balance can flatten lifetime taxes.

• Roth is a tax treatment applied to IRA or 401k
• Difference between workplace plans and individual accounts
• Traditional pretax: deduction now, taxes later
• Roth: taxes now, tax-free withdrawals later
• How to choose using the 32% bracket rule of thumb
• Targeting a 50-50 Roth vs pretax split by retirement
• RMD ages, factors, and penalties explained
• Case study on RMD-driven tax spikes
• Strategies: stop pretax contributions, use Roth conversions, exploit tax windows

Please consult with a professional before acting on any information shared in this podcast pertaining to financial, investment, legal, or tax advice

To learn more about Stansell Wealth Planning visit:
https://www.StansellWealth.com
Stansell Wealth Planning
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Plano, TX 75024
469-606-2040

Chapters

• 0:16 Welcome And Preview Of Topics
• 1:31 Roth Is A Tax Code, Not An Account
• 2:47 401k Vs IRA Explained
• 4:23 How Traditional Pretax Contributions Work
• 6:08 Birth Of The Roth And Its Benefits
• 7:23 Clarifying Roth 401k Vs Roth IRA
• 8:45 When To Choose Pretax Or Roth
• 10:45 Aim For A 50-50 Balance At Retirement
• 12:45 RMDs: Ages, Formulas, And Penalties
• 15:09 Case Study: Jeremy’s Future Tax Trap
• 18:14 Fixes: Stop Pretax, Use Roth Conversions
• 20:41 Three-Question Framework And Closing

Transcript

Speaker: 0:16

Hey everyone, welcome back to the Stansell Wealth Podcast, empowering you with information and encouragement on your finances. Hope you've enjoyed the last couple of weeks of podcast. We have had estate attorney Janelle Creme going over estate planning last week. I went through 2026 checklist roadmap a couple weeks before that. And then really excited for next week. Next week, we have Mason Whitehead of Churchill Mortgage going over current mortgage rates, where he sees rates going, when to start the pre-approval process, and more. Should be fun. So uh for today, good topics too. Um, if you're watching this on YouTube, it is the end of the day. So I'm looking rather tired now that I'm looking at myself on the video. So this may be a good audio one if you don't want to look at my uh red eyes and uh a long day of work. Uh, but I ironically, in saying that, at the end of this podcast, I do share a screen and go over a visual. So I take that back. You may want to actually watch this one. If you're usually a listener, you may want to go uh on the YouTube, on YouTube version and uh see my visual uh here in a little bit. So, anyways, for today, excited to dive in a topic as old as time. It seems like uh Roth versus Pretax. What is the difference? What are they? Why you should do one over the other, right? Topic as old as time, a lot of confusion. I get a lot of questions, a lot of confusion on this too. I'll ask, uh, hey, you know, or tell a client you should contribute to the Roth portion of your 401k, and they say, Ah, I don't have a you know, I don't have a Roth IRA, I have a 401k. And it's like, well, that's that's not what I'm referring to here. So hopefully this uh clears up some confusion. So what is a Roth? A lot of confusion on it. A Roth is not an account. So repeat after me. A Roth R-O-T-H is not an account, it's a tax coding to an account, meaning you can have a traditional IRA and a Roth IRA. The Roth portion is just telling you how the taxes worth work, right? So, and you can have a traditional 401k and you can have a Roth 401k. Once again, IRA is the account, 401k is the account, Roth is telling you the tax treatment of that account. Okay. So also, distinct difference here, get a lot of confusion on this too. 401k versus an IRA. 401k is just a retirement plan uh that's linked to an employer. So any workplace plan, it's gonna be your 401. All it is is section 401, subsection K of the IRS tax code. It talks about retirement options for employees in a workplace plan. So that's why it's called a 401k. For a nonprofit, it could be a 403B. Uh deferred comp, it's 457. There's a lot of different lingo here, but for this podcast to keep it simple, 401 is a retirement plan at work, right? You contribute to it every paycheck. Um, you have a certain 10, 20 different mutual funds they allow you to have. There's usually an employer match. That's a 401. An IRA is an individual retirement account. So it's a retirement account not associated with the workplace plan. It's an individual retirement account. You can have it anywhere. Uh, my clients with me, that's what they have, right? We our custodian is Charles Schwab. A lot of common custodians, Charles Schwab, Robin Hood, Fidelity, Vanguard, uh, a lot of retirement options out there. So once again, you can have an IRA, which is a traditional pre-tax, or you can have a Roth IRA. Once again, it's still an individual retirement account, but the Roth tells you the tax coding around it. To get back into Roth versus traditional slash pre-tax, an IRA and a 401k were invented in the 1970s as a way for people to save for their own retirement. When they were invented, they gave people a tax deductible way of saving for retirement. So to incentivize you to save for your own retirement, the IRS and Congress said, hey, we'll give you a tax deduction when you add money to a 401k or an IRA. Great. So you put money in an IRA or 401k, you receive an immediate tax deduction, and you can invest that money. So the example I always give, if you make $100,000 and you contribute $20,000 to your 401, your traditional 401k, taxable income is immediately reduced by $20,000. You're going to pay taxes on $80,000, right? Right off the top, you're saving in taxes. The IRS is taxing you on less. The only problem with that is you pay full income taxes when you take that money out in retirement. So fast forward, you're in your 60s, you're in your 70s, you say, hey, Cody, our fence blew over. Can you send us $20,000 from my IRA? We send you that $20,000. We also tend you to send you a 1099R tax form that you have to report on your income taxes for that year. You have to report that $20,000 as income. So think of tax benefit when you put money in, but you're going to have a tax hit when you take money out in retirement. Over those next 20 years, from the 1970s to the 1990s, people in Congress started complaining enough that there were they didn't like paying taxes on withdrawals in retirement. So surprisingly, uh President Clinton signed into law the invention and the creation of the Roth IRA, right? It's named after Senator William Roth, who came up with the idea. By the way, wouldn't it be really cool if there was an investment account named after you, right? The Stansell IRA that generations and generations use in the future. Wouldn't that be pretty cool? So never heard of William Roth. Uh, couldn't tell you anything about him. I'm sure not a lot of people know about him or that, but his legacy lives on from this one little retirement account invention that he had. So, anyways, with a Roth IRA or 401k, it's the exact opposite of the traditional 401k pre-tax 401. So with a Roth IRA or 401k, you receive no tax deduction when you add money to it. But you also never pay taxes on withdrawals and retirement. So think of this as no tax benefit when you add money. So previous example, you make 100 grand, you put 20 grand into the Roth portion of your 401k. The IRS still taxes you on $100,000. They don't care that you add money to your to your Roth. Okay. Um, but once again, no tax hit when you take money out. So no tax benefit when you add, but also no taxes when you take out. Nowadays, almost every single 401 at work offers you the ability to contribute to the Roth portion of your 401. Yes, that's right. You can contribute to your 401 and have a bigger tax-free bucket in retirement. It's called the Roth 401k. So look this up beforehand. Stats will tell you 93 to 96% of all 401ks in 2025 had Roth options. So odds are yours does too. So this is where a lot of confusion comes in. When I talk to clients and tell them to add to their Roth 401, a lot of times uh I hear back, you know, they hear me say Roth and they think of Roth IRA, and they say, Well, I don't have a Roth IRA. And it's like, that's not what I'm talking about. Do you have a Roth portion of your 401? When you sign up for a 401k or when you add money to it, you can decide either the traditional 401k where you get a tax deduction, but you pay taxes later, or you can contribute to the Roth portion where there's no tax benefit today and uh no, but no tax in retirement either. So remember, a traditional 401k and IRA was established first. That's why they call it a traditional 401k. Um, it was created in the 70s and the Roth wasn't invented until 1997. But it's really a tax deductible or pre-tax account. So all of these lingos are the exact same. Traditional is pre-tax, which is tax deductible. So anytime you hear, oh, my tax deductible IRA, it's a traditional, it's a pre-tax account. I'm gonna refer to it as traditional and pre-tax for this podcast, but just whenever you hear that, it's the I'm referring to that kind of account. So when would you want to contribute to uh a traditional 401k, right? The one where you get a tax deduction today, but you pay taxes in the future. Um, well, obviously it's when you need a tax deduction. So if you're in a higher tax bracket, and for us, that's 32% and above, that's a pretty high tax bracket in our opinion. Um, which in 2026, if you're married filing jointly, if you if your taxable income is above $403,000, you're going to be in the 32% tax bracket. If you make more than that, you and your spouse combined, or just you, um, you're going to be in the 32% bracket or higher. Therefore, hey, it may make sense to get the tax deduction this year because our tax bracket, our tax situation is pretty high, right? A third of every dollar that we make is going to the IRS. Let's let's get as many tax deductions as we can. If you're single uh or married filing separately, that number is $202,000. So if you're single and you make more than $202, you're gonna be in a 32% tax bracket. Yeah, let's probably get a tax deduction today and we'll worry about the taxes down the road. Okay, so that's one way to look at it. Um, if you make less than this, contribute to your Roth 401k or Roth IRA. Don't worry about it. You won't receive a tax deduction. But once again, you're in a reasonable tax bracket in our opinion. So don't worry about the tax deduction right now. Go for the tax-free growth and never worry about tax law on this money again, right? So that's the first factor is what's my current income tax bracket? How much do I make? Whether I decide to do the pre-tax or the Roth portion. The second factor is balancing Roth versus traditional balances. And when I say that, I mean, so once again, pre-tax traditional uh deductible balances versus your Roth balances. We want a 50-50 split of Roth versus traditional balances day one of retirement. So you if you have $2 million saved, let's say, uh the day that you retire, we want you to have $1 million traditional slash pre-tax, $1 million Roth. Okay. So what that does is that gives us flexibility in retirement. When you need money, we'll look at your current Social Security income, what income number keeps you below a Medicare premium credit. You know, we can gain the tax code when you need money from your accounts. If you need 50 grand, we can send you 20 grand from traditional and 30 grand from Roth or vice versa. We can kind of game the tax code, right? It gives us tax options. Um, so if you're 50 or 40 uh years old and you have, you know, a 70-30 mix, right? Let's say you have a million bucks and 700 grand is traditional and 300 grand is Roth. You know, how much do you need to contribute uh over these next coming years for that balance to be back to 50-50 on day one of retirement, right? We go over this with our clients. That's one of the biggest things that we do for clients in their 40s and 50s is what trajectory are we on? And are we are we on point with that 50-50 balance day one of retirement? So that's the two factors. The third one, the last one is avoiding or reducing RMDs. MD stands for required minimum distribution. And if you never heard of that before, I go over it right here. If you have heard of it and you're familiar, obviously this is gonna make make sense to you. But it's basically it's the amount that the IRS requires you to withdraw from your pre-tax slash tax deductible slash traditional IRAs in 401ks. Okay, I know that was a mouthful, but it's the IRS's way of saying, hey, you when you added money to these accounts, we gave you a tax deduction. So later in life, we're gonna make you take withdrawals from that account so that you can what? Pay taxes on it, right? They want their bowl of blood. It's the modern day mafia, they're they're gonna get their tax dollars, right? So that's their version of the tax of RMDs. There are no RMDs on Roth accounts. Let me repeat that. If you have a Roth IRA, you don't have to take out money at a certain age. Why? Remember? Because those withdrawals are tax-free. So the IRS isn't gonna make you take money out of those accounts. They don't care, they're not gonna get their tax dollar. They're only gonna make you take uh money out of accounts that you have to pay ordinary income tax on, right? So, really quickly, if you were born between 1951 and 1959, your RMD beginning age is 73. So the year that you turn 73, you must start withdrawing in that year. If you were born 1960 or later, that age is age 75. So depending on when you were born is what uh the first age, the first year that you must start taking RMDs. How much must you withdraw? It's a formula, right? Whatever your balance is of all the pre-tax, all the traditional accounts that you have, is multiplied by 4.07% when you turn 75. Why that number, who knows? It's an iris chart, it's a formula. I don't make the rules, I just follow them, right? So for every $100,000 you have in pre-tax slash traditional, that's $4,070 distribution that you have to take out, right? So doesn't sound like a lot. Obviously, if it's a million dollars, that's more like $40,000, right? Um, if you don't take that minimum amount, it's a 50% penalty. So instead of paying 22% in taxes, you'll pay 50% in taxes. Don't recommend just ignoring it and not doing it, right? And hard part is the factor increases as you age, right? So when you turn 76, it's not 4.07% anymore, it's 4.22%, right? The factor goes up every year. Couple that with odds are your investment balance goes up every year, and lo and behold, you're looking at increased RMDs every year in retirement. So, how can we avoid reduce RMDs? Remember, there are no RMDs on Roth money. So this is another reason to do uh Roth during your working years. So hear me. If you're in your 40s, 50s, this is your signal uh to look at increasing how much you're contributing to Roth IRAs, right? I'm gonna walk you through an example, kind of what I mentioned earlier. On um, I'm gonna give you a visual here. So let me share my screen. This is a real client that I'm gonna show you right now. His name is Jeremy. Jeremy is 47 years old. This is a real situation. I'm not making this up. We he and I met a couple of weeks ago and went over this exact same situation. So Jeremy is a lot like my typical clients. He has a majority of his money, a majority of his retirement money in traditional slash pre-tax 401k. And that balance right now is 711 grand. So he's 47 with 700 grand. He's doing well, making good money, you know, feels like he has life volatile, and he does, but he's about to run into a train wreck if we didn't go over this in the what we were talking about. So he is not adding to his pre-tax 401k anymore after we talked about it. He the only portion that's going into the pre-tax 401k is employer, is his employer match, and of course, just typical investment returns. So there's a lot of data on here, and I don't want people to get confused. There's a lot of data on here. Basically, I'm gonna fast forward each one of these rows is a different calendar year and the age that Jeremy turns in that year. So we're gonna fast forward to 2052. He is age 74. Okay, Jeremy will have 83 grand of Social Security coming in, and he needs to spend just a typical lifestyle. He wants to spend about 142 grand uh at age 74. So 83 is coming in, he needs to spend 142. Uh, he'll have about four grand of taxes, right, in retirement, not too much. And so his total spending is gonna be 146. And so above Social Security, he basically needs 63 grand from some source to have his normal lifestyle. You know, this is typical, no big deal. We'll send Jeremy five grand a month from his retirement portfolio. I mean, heck, he has at that point, he'll have about six million dollars, six point six million dollars. So sending him sixty grand from his portfolio, not a problem, no big deal. The only problem is, remember, um, he is date of birth is 1960 or younger, right? So his RMD age is 75. So the very next year, notice this column right here, required minimum distributions. For every year before age 75, they were zero. But at age 75, he must withdraw at least $189,000 from his accounts. Why? The IRS wants their bowl of blood. That's 4.7% of his current pre-tax 401k balance at that time in life. And notice here, once again, he needed only about 60 grand from his portfolio uh to live the lifestyle that he wants to live, but he's got to take out at least 189. So he's got to take out 120, $130,000 from his 401k or his IRA on top of what he really needs. He'll pay taxes on all 189 just to put that 120 or 130 in his savings account, right? So he'll pay taxes on all of it. And notice here, his tax bill when he was 74 was about four grand. Notice this. How about a $37,000 tax increase next year? Not good, right? And my point earlier on the factor increases every single year, and your balance probably keeps going up. He every single year he's paying about five grand more in taxes as he ages. Right? 79, he'll be paying 60 grand in taxes. 80, 66 grand. And so over time, you know, eight years later from 75, he's basically doubled his tax bill. And soon enough, when he's 86, notice here, he was in the 24% tax bracket. His RMD alone is pushing him into the 32% tax bracket. So this is the stuff that we want to avoid. If he just kept doing the pre-tax portion of his 401k and kept getting a tax deduction a day, it's almost a train wreck when he turns 75 and he's going to pay taxes on money that he never intended to. If you are age 40, age 50, and you're saving enough for retirement, you have a good emergency fund, you don't have any debt, you're probably doing good with your investments and everything's fine. This is a great example of having an advisor and going through, you don't know what you don't know, right? And so these kind of topics are a big deal about that. This is what we can help you with is going over avoiding situations just like this. And in reality, how can we avoid this situation? Don't add to the problem, don't keep adding to your pre-tax or tax-deductible uh 401k anymore to compound this growing balance, right? So that's one way. Stop doing that. Second one is what's called the Roth conversions. That's where we're taking a portion of us pre-tax or tax-deductible balance and converting it over to a Roth IRA. Very well-known strategy in the industry. We do it all the time for clients. Uh, this is where you take that balance, move it over to a Roth IRA. You pay regular taxes on that amount that you convert, but there's no tax penalty. Okay. And there's also no minimum, no maximum, right? So you could be 30 years old, 40, 50, move a portion of your pre-tax or traditional 401k into your Roth 401k or Roth IRA. No penalty. It's not a withdrawal. You can convert $1,000 that year. You can convert your entire balance if it's $100,000 or a million or $10 million. Uh once again, you're going to pay taxes on that amount. So the IRS doesn't put a cap on that. They'll text, they'll take. Their tax dollars if you're okay giving it to them. So for Jeremy, what we're gonna do is convert about 30 grand a year every single year. Once again, he's 47. We have a long runway, and that's the beautiful part is we have a long runway, you know, 25, 28 years to kind of avoid this problem. We're gonna convert 30 grand per year while he's working, and then once he retires, we're really gonna get aggressive because he won't have that high income anymore, and we'll convert more in those years. It's what we call a tax window. We talk about it in some other podcasts, and that's a different topic for a different day. Um, so those are the three factors of why Roth versus pre-tax we're biased. We like Roth because I've never had a single client in their 60s or 70s say, Man, I just I just wish I had less tax-free money or you know, less tax-free balance of investments. No one's ever said that. 70-year-old you is gonna thank current day you for being aware of this kind of stuff. So once again, the three factors should you add to your Roth 401k or your pre-tax 401k? Question one, what tax bracket are you currently in? 32% or higher, it may make sense to do pre-tax because it's such a tax deduction. Anything below 32%, let's do Roth. Second factor, how are you tracking on that 50-50 split at retirement? Remember, we want you to have half your money in pre-tax, half your money in Roth. How are we on that trajectory? If a majority of your retirement assets are pre-taxed today, you may need to contribute to Roth to kind of catch up on that balance. And then third one, our RMDs, required minimum distributions at 73 or 75, going to be significantly more cash than you need. Remember with Jeremy, he only needs 60 grand from his account, but year one, he's got to take out 190 basically, just to pay taxes on 130 that he doesn't really need. So after Social Security and any other income coming in, um, if you don't need all of that money, we need to act on it. Flip side, if he needed 60 grand a year to live on and his RMD is 60 grand a year, just ironically with balances and everything, I'm not near as concerned, right? Because, okay, you need that money anyways, you and you have to take out that money in retirement. That kind of lines up a little bit easier and it kind of makes more sense. Um, but if that's not the case, if it's significantly more than how much you need, uh, then we need to act on it now. So hopefully that's helpful. Uh went over uh this was a longer one than it usually is, but I thought it would be very useful. I get a lot of these questions, Roth first, pretext. As always, appreciate you guys. God bless you. Have a good rest of your day. Thank you for listening to the Stansell Wealth Podcast. This podcast is for informational and educational purposes only. It is general in nature and may not apply to your specific situation. Please consult with a professional before acting on any information shared in this podcast pertaining to financial, investment, legal, or tax advice. The views expressed by Cody and his guests do not necessarily represent those of Charles Schwab, Victory Financial Group, or any other organization.