Is a Roth 401(K) a good idea? Personal finance guru claims he lost $400,000 on popular plan

A personal finance expert has predicted that he lost nearly $400,000 in retirement income by investing in a Roth plan — and he wants to warn others not to make the same mistake.

Derek Sall, 38, believes the difference between the tax he’s already paid on his income and the potentially lower tax he’d pay when he retires means he’s missed out on significant savings.

With a traditional 401(K) plan, employees don’t have to pay taxes on their retirement savings, but they do pay income taxes during retirement.

By comparison, a Roth investor gets a tax bill upfront, but this means he gets a tax break when he retires.

“You’re much more likely to have a lower income when you retire than you are now, so you’re likely to fall into a lower tax bracket in the future,” Sall, who lives near Grand Rapids, Michigan, told DailyMail.com .

“For that reason, it makes sense to take your tax break now and not invest in a Roth,” says Sall, founder of LifeAndMyFinancessaid.

So in other words, you would decide not to pay a 22 percent tax rate now, but instead invest in a traditional plan and save that 22 percent and pay an average of 5.7 percent when you retire. It’s a huge difference.’

It’s the same distinction for an IRA, but these are just investment accounts that a person can open through a bank, an investment company, or a broker, rather than a workplace or employer-sponsored plan.

In real terms, the taxable income of an employee with an annual salary of $70,000 who pays $10,000 into a traditional 401(K) plan would be reduced to $60,000 per year.

The $10,000 that goes into their retirement savings isn’t taxed.

However, when you withdraw the money in retirement, you will owe income tax based on your income and tax bracket at that time.

By comparison, a Roth 401(K) investor with the same annual salary of $70,000 and $10,000 in retirement contributions would now pay taxes on the total $70,000 – with no deductions.

But when they come to withdraw the money, they don’t pay any fees.

In addition, with a Roth plan, you pay no tax on the investment income generated by your plan.

For example, if your traditional 401(K) plan has grown from $10,000 to $30,000 by the time you retire, you’ll pay taxes on the full $30,000.

But with a Roth 401(K), you don’t have to pay taxes on that $20,000 profit.

For these reasons, financial planners have often recommended Roth plans to young earners.

But Sall said many employees are being misled. He calculated how much he would have saved if he had invested in a traditional 401(K) between the ages of 25 and 37 – compared to how much he would have saved in his Roth account.

“With a traditional I would have made about $1.9 million, but with a Roth it was about $1.5 million,” he said. “Nobody knows this and they’re all tricked into saving in a Roth.”

Sall also explained that there’s a difference between the marginal tax rate — the tax rate of the bracket you’re in — and the effective tax rate — the average tax you pay — in retirement.

“Putting your money into a traditional IRA or 401(K) defers the marginal tax rate (the top tax bracket) so that you can pay the effective tax rate (the average rate) when you retire.”

By contrast, if you invest in a Roth, you’re likely paying a higher tax rate today to save a lower amount for retirement, he added.

If you are in your early years of earning, making a large contribution to your retirement, and plan to retire each year much more than you earn today, then you should probably contribute to a Roth IRA or 401 (K ), Sal said.

If not, you’re better off investing in a traditional one and deferring your taxes until retirement, he added.

It’s critical that Americans find a retirement plan that’s right for them — after a recent survey revealed a worrying disparity between what people expect to need to retire comfortably and the amount they have in savings.

According to Northwestern Mutual, on average, people believe they should set aside $1.27 million for retirement. Still, they typically only saved $89,300 — just 7 percent of the target amount.

The majority of American workers rely on an employer-sponsored 401(K) for their retirement plan.

Auto-enrollment means that a fraction of an employee’s salary goes directly into their 401(K) from their salary, which is then matched or partially matched by the employer.

The financial industry regulatory authority says most employers use a standard 3 percent contribution.

However, employees are encouraged to increase their co-payments – especially if their salary increases.

Historically, if you paid into a Roth account, your employer would put their matching amount into a typical 401(K).

However, new rules mean that employers can choose to match your contribution in Roth dollars.

Not all experts are convinced that a Roth plan is a costly mistake – many still argue that it is a valuable tool for building wealth for the future.

Investment advisor Patrick Donnelly told DailyMail.com that the main benefit of a Roth account is that it protects investors from future income tax increases.

“There will be times when, for certain individuals, a Roth just doesn’t make sense, but I would argue that Sall is overlooking an important element in contributing to a Roth, and that element is future tax rates,” he said.

Donnelly, van Donnelly financial servicescontinued, “If you’re contributing for retirement, you should consider what your taxable income is now and what it will be when you retire, but what he needs to consider is the outlook for future tax rates.”

“We are in a relatively favorable tax environment today for both high and low income earners, compared to historical income tax rates, due to the tax legislation introduced by the Tax Cuts and Jobs Act in 2017.

“Our current debt and deficit are on an unsustainable trajectory, and at some point the federal government and our tax system will be faced with this unsustainable amount of debt.”

Donnelly projects that this means the US is looking forward to an extended period of substantially higher average tax rates in the future – which he says could reach peaks of 15 or 17 percent.

“That’s going to hurt retirees across the board as they move to tax-deferred vehicles — your traditional IRA and traditional 401(K) plans,” he added.

“Our current tax code expires in January 2026, so we already know that tax rates for most households will increase by 3 to 4 percent in a few years.

“If you save for your retirement in a Roth now, you’re essentially hedging against those higher tax rates in the future. This makes Roth IRAs the most powerful wealth-building tool at our disposal today,” said Donnelly.

If you’re not sure if you’re best suited for a Roth or a traditional plan, it’s worth talking to an advisor about your options.