The Roth vs. traditional retirement account debate has become highly debated in financial circles. With federal deficits climbing and tax policy dominating headlines, many investors have concluded that Roth contributions are the obvious choice. After all, if tax rates are going up, it is better to pay taxes now at today's rates, right?
Not so fast.
Recent analysis of federal tax data spanning from 1913 to 2024 tells a more complex story, one that challenges the reflexive shift toward Roth accounts.(1) The findings suggest that for many high earners, traditional pre-tax contributions followed by strategic Roth conversions in retirement may deliver better outcomes than contributing to Roth accounts during peak earning years.
The Marginal vs. Average Rate Gap
The core insight centers on a fundamental distinction. When you contribute to a traditional retirement account, you receive a tax deduction at your marginal rate, the rate applied to your last dollar of income. When you withdraw those funds in retirement, you pay tax at your average effective ordinary rate across all income sources.
This potential gap can matter enormously. According to the historical analysis, individuals with current marginal tax rates above 30% would have withdrawn funds at lower effective tax rates in retirement in the vast majority of historical scenarios.(1) This held true even during periods when top marginal rates exceeded 90% during World War II and the Korean War era.
If you're currently in the 35% marginal bracket but expect to withdraw funds in retirement at an average effective rate of 20%, you're creating significant tax arbitrage by deferring income today.
The Case for Strategic Conversion
The research points toward a sequencing strategy: contribute to traditional accounts during high-income years, then convert to Roth during lower-income periods.(1) This approach allows you to capture the tax deduction at high marginal rates while managing the conversion tax at lower rates during retirement.
Without conversions, Required Minimum Distributions create a steadily increasing tax burden as traditional account balances compound. With strategic conversions performed during early retirement years when income drops, the overall lifetime tax liability decreases substantially. This timing advantage compounds over decades. The tax savings from traditional contributions during peak earning years can be invested and allowed to grow, while conversions happen later at more favorable rates.
What About Future Tax Increases?
The analysis doesn't ignore the possibility of rising tax rates. Historical data shows remarkable volatility in marginal tax rates, particularly during the mid-20th century when top rates exceeded 90%.(1)
Yet even accounting for dramatic rate increases during wartime, the conclusion holds for higher earners.(1) Your personal tax situation changes more dramatically over your lifetime than national tax rates typically do. Moving from peak earning years to retirement usually involves a larger drop in tax brackets than policy changes would impose.
There's another historical pattern worth noting. While nominal tax rates have declined over the past century, Congress has simultaneously eliminated deductions and broadened the tax base.(1) The net impact on actual taxes paid has been more modest than headline rates suggest. Future changes may follow this pattern, targeting specific planning strategies rather than dramatically raising rates across the board.
Real Planning Considerations
Large traditional account balances do create legitimate concerns. RMDs can push retirees into higher brackets, trigger Medicare premium surcharges, and cause more Social Security benefits to become taxable.
However, these issues often signal the need for more sophisticated distribution planning rather than abandoning traditional contributions altogether. Partial Roth conversions during strategic windows, typically the years between retirement and when RMDs or Social Security begin, can address these concerns while still capturing the benefit of traditional contributions during high-income years.
The Bottom Line
For individuals in their peak earning years with marginal rates substantially above their expected retirement rates, the math generally favors traditional contributions followed by strategic conversions. This doesn't mean Roth contributions never make sense. For younger workers in lower brackets, those expecting dramatic income growth, or situations with unique estate planning considerations, Roth contributions can be the right choice.
But defaulting to Roth simply because of vague concerns about future tax increases often leaves money on the table. Personal circumstances, particularly the gap between your current marginal rate and future effective rate, matter far more than predictions about tax policy.
Good tax planning responds to what you know about your situation today while maintaining the flexibility to adapt tomorrow.
Source:
(1) Kitces, Michael. "Why Pre-Tax Retirement Contributions Are Better Than Roth In Peak Earning Years." Nerd's Eye View, Kitces.com, September 25, 2024.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.