Disclaimer: This is NOT investment advice and I am NOT a financial advisor. Always consult a professional before doing anything with money or wrestling an alligator or cutting someone off in traffic.
Do you ever debate yourself? Of course you do.
If you’re reading this, it means you’re probably human. And humans love debating themselves. We do it before we make decisions. We do it after we make decisions. We do it in bed at 2am to keep ourselves awake just for good measure. We are natural sadists.
“Should I get a green Subaru or a black one?” (Hint: neither. Keep your current car. It’s paid off.)
“Should I move somewhere with a warmer climate?” (Hint: It doesn’t matter. Your disposition isn’t affected by the weather as much as the quality of your attention.)
“Should I buy at the top or sell at the bottom?” (Hint: both. If you’re me buying Ethereum.)
We adapt to new things so quickly. In a world of limitless gadgets, endless glimpses into other people’s lives on social media, and millions of possible romances at the swipe of a finger, we as consumers have never had more opportunities for buyer’s remorse even when we haven’t purchased anything.
So it’s no wonder when I switched my 401(k) from Traditional contributions to Roth contributions that I would second guess it a year later.
Did I make a mistake? Should I switch it back? What direction is the wind blowing today?
To answer those questions, allow me to set up the wholly unnecessary and painstaking over-analysis of every financial decision I make.
Why I Made the Switch
Did you even know you could switch your old, boring, Traditional 401(k) into a sleek, sexy Roth 401(k)?
Well, you can. And I bet that’s the first sentence you’ve ever read with both the words “sexy” and “401(k)”.
Technically, you are switching your contributions, not your vested or unvested balance. I mean, you can switch your balance too if you want, but you’ll take a massive hit on taxes. Let me explain what I mean.
Most 401(k)s from employer-sponsored retirement plans will set you up with Traditional contributions into a target-date fund for the year you plan to retire by default. This means the money you put into your 401(k) and the growth of that money won’t be taxed until you withdraw it (usually in retirement).
A standard target-date fund will be a mix of stocks and bonds that will start as mostly stocks when you are younger and then slowly and automatically switch to more bonds as you get older and closer to retirement.
I didn’t like the sound of this in a world with unlimited money printing, so I started tinkering.
First, I told my target-date fund to take a hike. I had a few alternative options when I opened up my account and looked under the hood. By options, I mean I had a few other types of funds I could choose from besides the vanilla target-date fund.
Because I’m 30 and have no use for bonds paying next to nothing, and I think I can stomach the volatility inherent to stocks, I decided to go all stocks.
To accomplish this, I reallocated my entire portfolio to a couple different index funds. One tracks the S&P500. One tracks the Russell 2000. And one tracks Asia-Pacific growth companies. The details aren’t as important as the fees of these funds.
See, my target date fund had an expense ratio of 0.75. That means that this fund would have been charging me 0.75% to “manage” my money for me from now until I die. No thanks.
That’s literally tens of thousands of dollars on a long enough time horizon and because I maximize my contributions each year. The new funds I chose were all indices, so they charge around 0.03%. Much better.
But they don’t reallocate themselves, so when I get older, I will need to do that myself if I want the volatility reduction inherent to bonds.
The second thing I did was switch my contributions from Traditional to Roth. Just like a Roth IRA, this means that I pay the taxes now out of each paycheck, and then the contribution gets put into my 401(k).
The beauty of this strategy comes when you consider that the growth of those contributions is all tax-free upon withdrawal. The growth is tax-free! The conservative compounded growth of $19,500 invested per year in the S&P for thirty years is about $3,000,000. Why would I want to pay taxes on the growth of three million dollars if I don’t have to?
Yes, I’d still be paying taxes on whatever money I put in as well as the meager contributions from my employer, but that’s only roughly $600,000. The other $2.4 million would be tax-free.
I know past returns are no guarantee of future performance, but let’s use this for the sake of conversation. I’d much rather donate that money to the most effective charities, leave it to my children, or buy a yacht when I’m too old and cranky to enjoy it.
Why I Might Switch Back
Here’s where the debate starts, and my sanity ends.
What if withdrawals from Roth retirement accounts begin to be taxed in the future?
I know what you are saying, “But Kevin, that’s the entire point of choosing a Roth account over a Traditional. Voters would never let a law like that be enacted.”
Don’t be so sure of yourself.
Voters would never let a law like that be enacted today. But what about 3 decades of exponential wealth inequality and a revolution that doesn’t give a damn about what you planned for in your retirement accounts?
Big things can change over time. Hell, civilizations collapse. You think the U.S. tax code is invincible?
This would mean I was taxed when I put the money in, and I’ll be taxed when I take it out. Talk about lose-lose.
I was reading Allison Schrager’s recent Known Unknowns post, and she seems to agree. Quote: “Personally, I’ve never totally trusted that the tax treatment of Roth accounts will still be in place when I retire. Too many affluent people have money in them, so they are ripe for taxes when the revolution comes.”
I know no one has a crystal ball, but I am considering going back to Traditional because she has a good point… with so much wealth inequality and the recent ProPublica leaks showing Peter Thiel’s 5 billion dollar Roth IRA; this could be the canary in the coal mine.
I know that this level of analysis and experience in investing is already tantamount to winning the game, but that’s what we do in the personal finance community – we min-max.
Am I overthinking it? Is this sillier than leaving a shopping cart in the middle of the parking lot instead of putting it in the corral? What would you do?
Email me, mail me a strongly worded letter, or put a comment below.
And if you really want to let me have it, add me on Instagram and double-tap my posts sarcastically. I’ll get the message.