152 – The Math Behind Roth IRAs

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The Math Behind Roth IRAs

Grab a pen and paper to help you decipher the math behind choosing the right retirement option.

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Bob and Shawn delve deep into the math behind putting money into a Roth IRA. This is a super informative episode for anyone wondering if they should be putting their retirement funds into a Roth IRA, go with a Traditional IRA, or even use a combination of both (or other saving means). As we at Christian Financial Advisors mention a lot, it’s just math! This includes the age at which you begin saving money, the age at which you pull money out, and your income at the time.

We highly recommend getting a pen and paper while listening to this episode to make it a little easier to comprehend. There are a lot of numbers and math that are mentioned, and following along while writing down what Bob and Shawn are saying will make this episode simpler to break down and understand.

Mentioned In This Episode

Intro:
Welcome to Christian Financial Perspectives, where you’re invited to gain insight, wisdom, and knowledge about how Christians integrate their faith, life, and finances with a biblical worldview. Here’s your Christian Financial Advisors’ host, Bob Barber and his co-host, Shawn Peters.

Shawn:
Welcome back to another episode of Christian Financial Perspectives. I’m so glad that you joined us today, and if you have not already, hit that subscribe button. If you like content on financial topics from a Christian perspective, well, what are you waiting for? Hit that subscribe button. Still waiting on about 80% of you that watch the videos to hit subscribe. I promise it doesn’t cost anything. Just one quick little click and it will actually help not only our channel, but also helps you because then the algorithm can find other videos, maybe like ours, that you also enjoy. So, do yourself a favor. Do us a favor and everybody else, and hit that subscribe button.

Bob:
Hey, same thing with the podcast.

Shawn:
That’s right. Yeah, that’s right.

Bob:
Absolutely.

Shawn:
Anyway, all right, now the announcement and advertisement’s over, Bob, what do we got for today?

Bob:
Well, we’re gonna discuss Roth IRAs. And I’m telling you, Shawn, this is a very marketed product in the financial market plan.

Shawn:
Yeah, for sure.

Bob:
And a lot of it at the time, it’s marketed as a one size fits all, and it is far from that. So I’m calling today’s topic.

Shawn:
Roth IRA isn’t for every person all the time, under all circumstances?

Bob:
It most certainly is not, but it’s marketed that way. And can you see in my outline. we have here: “Roth IRAs. Are they a good idea?”

Shawn:
Okay.

Bob:
It all depends on the math. You know how I love that. I always says it depends on the math, and do not invest in a Roth IRA until you hear this or you watch this because, and if you’re thinking about it, you definitely need to watch this and tell your friends if they’re thinking about it or family. Because like I say, it’s just marketed over and over and over.

Shawn:
And this isn’t clickbait. Do not invest in a Roth IRA until you watch this. So without further ado.

Bob:
All right. So the question of contributing to a Roth IRA, Shawn or doing a conversion, because that’s really heavily marketed too, should be, like I said, determined base solely on math. So let’s look at the math. Okay. So first let’s assume that you’re wanting to contribute to a Roth IRA about $500 a month. All right. That’s where a lot of people fall, $500 to $600 a month, without giving over or putting too much in the Roth. You can’t go over your limit, but I think it’s very important for you to think about what tax bracket are you in right now. And the question really boils down to, “Do you believe you’re gonna be in a higher tax bracket when you re you retire or the same tax bracket?” Shawn, I’ve noticed that over the years, and I’ve been doing this for over 30 years, that the majority of retirees are in a lower tax bracket when they retire than during their working years.

Shawn:
Makes sense, especially when you’re at the height of your career, you’re probably making more income pre-retirement than you are in retirement, because once you retire, just because you’re not working, I mean, there’s just a lot of things that you would think at that point that you wouldn’t need as much income, therefore the money maybe that you’re taking out of your retirement account. So Yeah, I would make the assumption that a lot of people are going to be at a lower tax bracket during retirement than they are during their peak career years.

Bob:
Well, Shawn, I have to say that I cannot think of a person that’s a client here, in my 30 years, that’s not. They’re all in the lower tax bracket, and I’m gonna use an example today of a normal household, family household income. Okay. And I know a lot of people say, well, that’s not my normal… well, it is, when you look at the family, when you look at both husband and wife working. It’s around 90k to a 100k a year. What that does, and I want to, we’re gonna put up a income tax the different percentages.

Shawn:
The different tiers.

Bob:
The different tiers of income taxes, and if you take a look at this right now, you’ll see for the 2023 tax brackets that you’re in a 12% bracket all the way up to $89,000, and then you enter into a new bracket. So assuming that person’s at a $100,000 income, the household income, the husband’s maybe making $60,000 or $70,000, the wife’s making $30,000 or $40,000 or vice versa , they’re in that a $100,000 income, then everything they’re gonna put into a traditional Roth IRA or a Roth IRA is going to be at that top tax bracket. All right. It’s not the effective tax bracket, it’s a top tax bracket. So, if you’re wanting to put money in a Roth IRA, for every $500, you need to subtract 22% of that.

Shawn:
Because of the…

Bob:
Income tax bracket

Shawn:
Since the Roth is the after tax contribution.

Bob:
That’s correct. That’s correct. So for every $500 that you’re gonna put into that Roth, it’s actually gonna be $390 or if you do wanna put the $500 in, you’ve gotta figure in, take apples to apples, you’d have to add 22% to a traditional, but in this case, so we’re gonna say $390.

Shawn:
So that $500 immediately turns to $390 because a $110 is going income tax?

Bob:
That’s correct.

Shawn:
So the $390 after tax, I noticed, Bob, you’ve got an interesting thing here. $390 after tax growing at an average reasonable rate of return of 8% for 20 years grows to approximately $230,000.

Bob:
Yeah. It’s very reasonable. I think an 8% return over a 20 year period is a very reasonable return in a growth portfolio, growth moderate type portfolio.

Shawn:
Which if you’ve got 20 years of retirement or more that probably would be in something more growth oriented.

Bob:
So, we’re really looking at the math, we’re digging into the math now. So, that $390 would grow to $230, a normal pullout rate is between 4% and 5%. So let’s assume a 4% annual withdrawal.

Shawn:
A little more conservative, say 4% annual withdrawal during retirement. So that gives us $9,200 a year, tax free.

Bob:
That’s correct. All right. Now there’s the flip side of it. The flip side of it is you take $500, all the money, because you don’t have to pay tax on that, and you put that into a traditional.

Shawn:
So pre-tax. Gotcha. All right. So now, we don’t have to pay anything with income tax right now on that contribution. So based on the same rate of return of 8% for 20 years, it would grow to approximately $295,000 or $65,000 more than the Roth?

Bob:
That’s correct. All right. But when you pull the money out, right, you gotta pay tax, right? Where in the Roth, when you pull the money out, you don’t have to pay tax. So the tax free amount from the Roth was $9,200 a year. The tax amount that you’re gonna pull out, if a 4% withdraw, you’re gonna pull out from $295,000 from the traditional IRA is now $11,800 a year. All right. So now you gotta go out and you gotta pay taxes on that amount of money.

Shawn:
So then the question is, and when you’re looking at tax return or you’re looking at the tax rates right now, if you’re under that $89,000 almost $90,000, then you’re gonna be at 12%.

Bob:
That’s correct.

Shawn:
Which is a lot lower than 22%.

Bob:
And lemme tell you how I arrive at that. So let’s say you want to be, you’re gonna be work during the retirement years. You want the same income, but you gotta realize that $30,000, $35,000, $40,000 with a spouse and spousal income, I mean social security spousal benefit, that’s gonna end up being $35,000 or $40,000 of your dollars. Okay. Even if you’re pulling $40,000 or $50,000 from your 401ks or IRAs, you’re not getting anywhere near that tax bracket.

Shawn:
Right. But then with the supplemented income from the social security,

Bob:
Which you’re not having to pay tax on.

Shawn:
Exactly. But then your actual livable income that you can use for expenses is still closer to what you had during your career.

Bob:
That’s correct. Now, in some cases you will have to pay some tax on some of those social security benefits, but in this case we’ve got the social security calculators here that we can put the numbers in and out of that $30,000 or $40,000 you may have to pay tax on a couple thousand dollars of that. All right. So you’re into 12% bracket. So the $11,800 that you’re able to take out of your traditional IRA, after tax is gonna equal $10,384. And you remember the other number with the Roth?

Shawn:
It was $9,200.

Bob:
That was $9,200. So that equals 13% more dollars every single year. So in this case that I’ve just mentioned, it does not make sense for somebody that is a hundred, a hundred plus income, to go do a Roth IRA. The math does not make sense.

Shawn:
When you factor in the income tax that you’re paying now.

Bob:
That’s correct.

Shawn:
And what that total net amount could grow to and that you then take an income off of compared with yes, you’re gonna have to pay tax on the traditional later, but because your tax bracket is so much lower during retirement, you actually end up being ahead.

Bob:
You do. And I’ve seen this over and over and over too, I can say over, I don’t know, infinity times. I see this when people are retired, they’re in a lower tax bracket, their taxes, they’re paying less in taxes and everyone thinks, well, I’m gonna be in a higher tax bracket. No, taxes are going up historically, and I wanna put a chart up there and I’ll get that chart so we can show that as we’re recording this, there’s a chart that shows historical tax rates in the high bracket. We’re actually much lower. And remember, tax rates are gonna compensate for inflation as you make more. So I rarely, like I said, if ever, meet a retiree that’s in a higher tax bracket. So, mathematically the only reason to do a Roth is if you think you’re gonna be making more money during retirement than when you’re working.

Shawn:
I guess I’m just trying to think under what circumstance would someone… I mean, if you’re in one of those situations or actually anticipate being in one of those situations, we’d love for you to throw that in the comments. But right now at least, I mean, what situation would there be that someone would realistically be making more in retirement in taxable income than during their career?

Bob:
Very not, I mean, not much.

Shawn:
Yeah. I guess if your pension and 401K and defined benefit and all this other stuff was just so crazy high that…

Bob:
The one exception, I guess the one exception I can say is I have seen retirees, but then they’re not really retired anymore. They go back into, they’re getting a retirement income and they go back into the marketplace.

Shawn:
I guess I could see that.

Bob:
And it does make sense to do a Roth, I think a younger couple, it makes sense to do a Roth because they’re not in that high tax bracket yet. Does that make sense?

Shawn:
Right, right. So, if currently your income is lower where you’re only in that 10-12% tax bracket, then it might make more sense. So as you progress in your career, well you know what, there’s a chance that you might be in a higher tax bracket than you are right now, but what that would mean though, Bob, is well five years from now or 10 years from now, that same couple may want to stop contributing to a Roth and start contributing to a traditional.

Bob:
Right. Or their 401k, 403b, 457, Thrift Savings Plan, TSA, they’re all the same thing. They all fall under the same category as what we call a qualified plan, but put the money in that.

Shawn:
Yeah.

Bob:
But there are Roth 401ks, and I’m seeing people that are making over $150,000 a year and they’re putting Roth in the 401k. It’s a mistake. It doesn’t make mathematical sense. Now, I can’t say for everybody it’s a mistake until we look at your specific situation.

Shawn:
Okay. Well it sounds like as a general rule, which again, results may vary and yes you should talk to a qualified advisor, but it sounds like the general rule is if you’re in the 10-12% tax bracket and you’re younger and earlier in your career, looks like the math would probably be on your side. It would make sense to do a Roth.

Bob:
It is.

Shawn:
But that doesn’t mean that just because you decided to do a Roth today, that 5 years from now and 10 years from now, that’s still the right option.

Bob:
That’s right. Or a conversion. You always hear these things about conversion. Why would you do a Roth conversion when you’re making $120,000 – $130,000 a year? That doesn’t make any sense. You have to pay all the tax on it as well. So, never trust your instincts when it comes to a Roth IRA. Trust the math, trust the math. I’m always saying it. You gotta trust the math.

Shawn:
You say it all the time, it’s just math.

Bob:
I love it.

Shawn:
But I think it’s good. I think it’s good. The reason why we obviously say “trust the math” so often is because the math helps you take the emotion out of the financial decision. Because many times, I mean we’re emotional creatures.

Bob:
And I rotate right back to where we were at the beginning of the program, Roths are very heavily marketed, they’re marketed in seminars as the one size fits all and they are not. Hopefully, I’m not gonna get a lot of advisors call and go, “Why did you do this program?” But I think the program needed to be made.

Shawn:
Wait, are you worried about the Roth IRA mafia?

Bob:
They could. Exactly. So is a Roth IRA right for you? You need to look at your situation. Give us a call, and let’s look at it. Let’s look at the math and see. And our phone number that you can call or text to is (830) 609-6986. Hey Shawn, I just got a text yesterday from someone in Pennsylvania saying they just heard the podcast and I answered them back, said thank you and they were asking about our fees as a fee based advisor and I’ve directed them to the right place.

Shawn:
Were they able to understand your accent?

Bob:
I hope so. Through the text? Exactly. And by the way, we appreciate all of you that listen across the nation and listening to this South Texas country boy. And hopefully I am just, I just lay it out there. That’s what I want to do. And so that’s the number (830) 609-6986. Call or text us or go to our website. Check it out and you can you can, from our website, you can make an appointment with different advisors here under the staff. And that is ChristianFA.com or christianfinancialadvisors.com. But you can abbreviate financial advisors and just put FA.com

Shawn:
And yeah, we work with people all across the country. As long as you’re not someone who has to sit face to face, we can do a Zoom so you can see our face and we can do phone calls.

Bob:
That was a question. Do you work with people across the country? I said, “With Zoom and email and DocuSign and text and voice. We can do it all.” Location no longer matters.

Shawn:
Well, once again, thank you so much for joining us today. God bless. And until next time, take care.

[CONCLUSION]

That’s all for now.

We invite you to listen to all of our past episodes covering many financial topics from a Christian Perspective. To make sure you don’t miss any of Bob’s upcoming episodes you can subscribe to Christian Financial Perspectives on iTunes, Google Play Music, Spotify, or Stitcher. To learn more about integrating your faith with your finances, visit ciswealth.com or call 830-609-6986.

[DISCLOSURES]

Investment advisory services offered through Christian Investment Advisors Inc dba Christian Financial Advisors, a registered investment advisor registered with the SEC. Registration as an investment advisor does not imply a certain level of skill or training. Comments from today’s show are for informational purposes only and not to be considered investment advice or recommendations to buy or sell any company that may have been mentioned or discussed. The opinions expressed are solely those of the hosts, Bob Barber and Shawn Peters, and their guests. Bob and Shawn do not provide tax advice and encourage you to seek guidance from a tax professional. While Christian Financial Advisors believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability.