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I've just moved to US and I started considering savings/retirement options (I'm mid-20 but I don't think it unwise to start early). I'm trying to max the contributions. I started to think if the ROTH accounts does not allow for de-facto larger contributions.

Assuming I contribute maximum amount of money (18000 USD for 2015 to 401k or 5500 to IRA) which would grow to some value I would get amount lower then that as I would pay taxes on it. However if I contributed the same amount to 401k ROTH/IRA ROTH I would get the full amount at the cost of paying tax now. While I could consider investing the saved money into a account it would be taxable for gains and therefore would cost more.

Am I missing something?

  • I've read through this question twice now and I still don't understand what you are asking. Can you summarize the question? – JohnFx Nov 22 '14 at 19:11
  • @JohnFx It was what JoeTaxpayer called density. In traditional IRA you contribute pre-tax dollars so you pay the income tax on earnings (when you withdraw) while in ROTH you don't pay it (you pay only on contribution). However as limits are the same you can withdraw more from ROTH assuming contribution of maximum amount and being in same tax bracket. – User Nov 22 '14 at 20:10
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I wrote the whimsically titled "The Density of Your IRA" to discuss this exact issue.

In the 25% bracket, your pretax 401(k) would have $18,000, with a future tax due. But the Roth effectively took $24,000 in pretax dollars, and put the $18K in post tax money in the account. Since the limits are the same, the Roth is a denser account.

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Yes, the annual contribution "limits" are effectively higher for Roth accounts than for the corresponding Traditional account, if that is what you are referring to, since the "nominal" limit is the same, but for Roth it's after-tax money, while for Traditional it's pre-tax money, which is equivalent to a lesser amount of after-tax money.

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For various reasons, if you can defer tax payment, it's good for you [when you can give uncle sam $x tomorrow, why give it today?]. Some reasons are, you may plan to return back to your country after x years and then you can pay tax at a lower bracket [e.g. convert 401k to Rollover-IRA then do Roth-conversion and pay lower tax bracket].

Paying now versus later is purely based on your anticipated future tax bracket. [if future bracket is same.. say 25% today and after say 20 years, 25%.. there is absolutely no difference between today payment or future payment of tax -- you can mathematically prove the returns are the same for Roth-IRA (or Roth-401k) versus IRA (or 401k)].

Having a bigger balance (in case of 401k compared to roth-401k) can also give you a sense of more security -- since there are provisions for hardship withdrawal (tax may be due)

  • "Having a bigger balance" - that doesn't apply when I intend to max out the 401k/IRA, does it? – User Nov 24 '14 at 5:57
  • @User "bigger" in the sense, you did not pay the tax now; e.g. situation A) $18k in 401k & put that saved tax money of $6k (at 25% bracket) in say roth-ira/individual non-tax privileged account. Situation B) $18k in post-tax-roth-401k. In B, the $6k tax money is gone - it doesn't appear anywhere as part of yours -- true this is something you have to eventually pay as tax; but in one case you have balance of "$24k" and in another "$18k". With $18k (situation A), you have some flexibility on when/how you pay the tax [e.g. in a future year when your tax bracket may be lower]. – Karthik S Nov 24 '14 at 13:01
  • @User yes, you are right that you can save more using Roth version and avoid tax on growth each year [if you held the tax savings in a normal account]; as I see the only drawback is you lose the flexibility of timing tax payment [e.g in a future year of lower income if that happens]; also there may be some benefits of reduced AGI (since 401k reduces AGI; i believe roth-401k does not) – Karthik S Nov 24 '14 at 14:17

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