Roth vs. Traditional
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Episode 583 released yesterday and in it I mentioned that assuming tax rates are the same going in and going out, you will have the exact same net worth regardless of whether you contribute to a Roth or a Traditional account (IRA, 401k, etc.).
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Hereu2019s the step-by-step example:
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Contribution:
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You want to take $5,000 of your income and contribute it to a retirement account.
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Traditional: This income is not taxed, so you get to contribute the full $5,000 which invests and compounds.
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Roth: The income is taxed in the current year and letu2019s say youu2019re squarely in the 22% bracket, so you pay $1,100 in tax on that $5k and you therefore invest $3,900
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Total Tax Paid on Contribution: Traditional = $0. Roth = $1,100
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Balance at Year 40 (assuming 8% annual growth rate):
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Traditional: $5,000 invested grows to $121,366.93
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Roth: $3,900 invested grows to $94,666.20
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Withdrawal:
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Traditional: Assuming you pay the same 22% tax rate on your $121,366.93, you pay $26,700.72 in Federal tax on withdrawal. This leaves you with a net worth of this investment of $94,666.21.
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Roth: You already paid tax on contribution, so your entire balance of $94,666.20 is yours to keep.
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Bottom Line:
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You have the same net worth in the Roth vs. Traditional horse race assuming the exact same income tax rate.
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Thereu2019s no difference!
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Sure, it might u201cfeelu201d better to only pay $1,100 in tax on the Roth contribution instead of paying $26,700.72 in tax on withdrawing your money in the Traditional account, but critically you have the same net worth.
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So, Roth vs. Traditional is simply a bet on income taxes.
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My strong expectation is that the FI Community will win dramatically using Traditional accounts because weu2019ll only be pulling out enough each year to cover our expenses and thereu2019s a massive standard deduction that lowers that income and then the lower tax brackets (currently 10% and 12%) will further lower the effective tax rate on our withdrawals.
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Email Security Tip
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I recently had someone try to hack into an email address that I use for a number of my financial accounts.
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This was a brute force attack and pretty unsophisticated, and my two-factor authentication (2FA) was up to the task this time.
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That said, it scared me pretty good.
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Our email accounts are maybe the biggest points of failure in our online security systems since many of us donu2019t use 2FA and sometimes have weak or reused passwords.
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Keep in mind that if someone has access to your email address, they can pretty easily reset the password on your essential financial (and other) accounts that use that email address as the contact address.
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I reached out to my friend Tom, a former FBI Special Agent and expert in cyber security (and two time podcast guest on Episodes 515 and 397) to ask him what I should consider doing.
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He reiterated that the gold standard for 2FA is a physical device called a Yubikey, and that I should use this wherever possible.
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As far as email addresses on your essential accounts go, hereu2019s what he said:
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u201cI use a specific Proton Mail email address for all of my financial stuff. Nothing else uses that email. And for both that email and my Gmail, I have them tied to my Yubikey. And then I have an old email that I use for unimportant things.u201d
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Take action securing your financial life today u2013 this is truly critical!
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