#39 - Pre-Tax vs. Roth
Would I rather invest on a pre-tax basis or invest in a Roth? It is one of the great debates of personal finance. Today I wanted to bring to light something that I think needs to be factored into the decision that many times is left out.
Typically when people analyze between saving on a pre-tax basis or to a Roth they assume that the tax savings from investing on a pre-tax basis are used in a way that builds net worth.
That assumption isn’t always the case though. If I qualify to make a $6,000 deductible contribution to my IRA and make the contribution, do I then save the tax savings that show up on my tax return? Or does it just get absorbed into living expenses?
If I just absorb those savings into lifestyle, how does that affect the decision to invest on a pre-tax vs. Roth basis?
Let’s look at an example assuming it is absorbed into lifestyle. Your balance in the Pre-Tax and Roth are the same- therefore any tax % owed on the pre-tax (10% assumption below) makes the Roth better from a net worth standpoint.
There are situations where the pre-tax balance could be withdrawn at a zero percent tax. Also, there are definitely situations where at least a portion, if not all, of the tax savings from the pre-tax deduction does flow into some avenue that actually builds net worth. I am simply saying we can’t always assume that it does.
There are about 50 other considerations to take into account when making this decision, but I wanted to bring to light this one as I think it is often overlooked. What actually happens to the savings on the pre-tax contribution plays a role in determining which saving type better improves your net worth.
Interesting Article(s) or Video(s)
Thank you for reading! What are your thoughts on investing on a pre-tax vs. Roth basis?