This is subtle and I may be missing something, but it seems to me that using a pretax 401k helps some but not that much, and the Roth scenario is only slightly worse than the regular investment account. Compare the three, chosen to be maximally favorable to your scenario:
You contribute to your pre-tax 401k, it grows (and inflates) 2x. You roll it over into a Roth IRA, paying taxes on the conversion. Over the next five years it grows 1.3x. You withdraw the contribution and leave the gains.
You contribute to your post-tax Roth 401k, it grows (and inflates) 2x, and then another 1.3x. You withdraw the same amount as in scenario #1.
You put it in a regular investment account.
Let’s assume your marginal tax rates are 24% for regular income and 15% for capital gains.
In #1 if you start with $100k then it’s $200k at the time you convert, and you pay $48k (24%) in taxes leaving you with $152k in your Roth 401k. It grows to $198k, you withdraw $152k and you have $46k of gains in your Roth 401k.
In #2 your $100k is taxed and $76k (less the 24%) starts in the Roth. When it’s time to withdraw it’s grown to $198k. Of that, your $76k of contributions are tax and penalty free, leaving you with $122k of gains. To end up with $152k in your bank account you withdraw $115k, paying $28k (24%) in taxes and $12k (10%) in penalties. You have $7k of gains still in your Roth.
In #3 your $100k is taxed to $76k when you earn it, and then grows to $198k. You sell $179k, paying 15% LTCG, and end up with $152k after taxes and $19k still invested (but subject to 15% tax when you eventually sell, so perhaps consider it as $16k).
So you’re better off in #1 than #3 than #2, but the difference between #3 and #2 is relatively small, and this is a scenario relatively unfavorable to Roths.
My claim isn’t “Roth 401(k)s are strictly better than putting the money in investment accounts” or “Roth 401(k)s are strictly better than pre-tax 401(k)s” but instead “when you consider the range of possible futures, for most people Roth 401(k)s are better than non-protected accounts and other protected accounts may be even better”.
Five years from when you open your account there are options for taking gains out tax-free even if you’re not 59.5 yet. You can take “substantially equal periodic payments”, but there are also ones for various kinds of hardship.
For Roth you mostly can’t take out gains tax-free. The hardship ones are limited, and SEPP doesn’t let you access much of it early. The big ones of Roth conversions and just eating the 10% penalty only work for pretax.
[As an aside Roth accounts are worse for most people vs pretax for multiple reasons, e.g. pretax comes with an option of converting or withdrawing in low income years at low tax rates. More details here.]
In #1 if you start with $100k then it’s $200k at the time you convert, and you pay $48k (24%) in taxes leaving you with $152k in your Roth 401k. It grows to $198k, you withdraw $152k and you have $46k of gains in your Roth 401k.
You pay taxes on the amount you convert, either from outside funds or withdrawals to you. If you convert $X you owe taxes on that as ordinary income, so you can convert $200k and pay $48k in taxes from outside funds. This makes pretax better.
Re your assumptions, they are not great for an AI-pilled saver. Someone who believes in short AI timelines should probably be investing in AI if they don’t have decisive deontological objections. NVDA is up 20x in the last 5 years, OpenAI even more. On the way to a singularity AI investments will probably more than 10x again unless it’s a surprise in the next few years as Daniel K argues in comments. So their 401k should be ~all earnings, and they may have a hard time staying in the low tax brackets you use (moreso at withdrawal time than contribution time) if they save a lot. The top federal tax rates are 37% for ordinary income and 23.8% for capital gains.
Paying the top federal income tax rate plus penalties means a 47% tax rate on early withdrawals from the Roth vs 23.8% from taxable. I.e. every dollar kept outside the the Roth is worth 44% more if you won’t be using the account after 59.5. That’s a wild difference from the standard Roth withdrawal case where there’s a 0% tax rate.
A substantially larger percentage in Roth than the probability you are around to use it and care about it after 59.5 looks bad to me. From the perspective of someone expecting AI soon this advice could significantly hurt them in a way that the post obscured.
My impression is that the “Substantially Equal Periodic Payments” option is rarely a good idea in practice because it’s so inflexible in not letting you stop withdrawals later, potentially even hitting you with severe penalties if you somehow miss a single payment. I agree that most people are better off saving into a pretax 401k when possible and then rolling the money over to Roth during low-income years or when necessary. I don’t think this particularly undermines jefftk’s high-level point that tax-advantaged retirement savings can be worthwhile even conditional on relatively short expected AI timelines.
I prefer pre-tax contributions over Roth ones now because of my expectation that probably there will be an AI capabilities explosion well before I reach 59.5. If I had all or most of my assets in Roth accounts it would be terrible.
Why would money in Roth accounts be so much worse than having in in pretax accounts in the AI explosion case? If you wanted the money (which would then be almost entirely earnings) immediately you could get it by paying tax+10% either way. But your accounts would be up so much that you’d only need a tiny fraction of them to fund your immediate consumption, the rest you could keep investing inside the 401k/IRA structure.
Some altruistically-motivated projects would be valid investments for a Checkbook IRA. I guess if you wanted to donate 401k/IRA earnings to charity you’d still have to pay the 10% penalty (though not the tax if the donation was deductible) but that seems the same whether it’s pretax or a heavily-appreciated Roth.
I think a lot of this depends on your distribution of potential futures:
What sort of returns (or inflation) do you expect, in worlds where you need the money at various ages?
What future legal changes do you expect?
How likely are you to have a 5y warning before you’ll want to spend the money you’ve put in a traditional 401k?
What are your current and future tax brackets?
How likely are you to be in a situation where means testing means you lose a large portion of non-protected money?
How likely are you to lose a lawsuit for more than your (unprotected) net worth or otherwise go bankrupt?
The first version of this post (which I didn’t finish) tried to include a modeling component, but it gets very complex and people have a range of assumptions so I left it as qualitative.
This is subtle and I may be missing something, but it seems to me that using a pretax 401k helps some but not that much, and the Roth scenario is only slightly worse than the regular investment account. Compare the three, chosen to be maximally favorable to your scenario:
You contribute to your pre-tax 401k, it grows (and inflates) 2x. You roll it over into a Roth IRA, paying taxes on the conversion. Over the next five years it grows 1.3x. You withdraw the contribution and leave the gains.
You contribute to your post-tax Roth 401k, it grows (and inflates) 2x, and then another 1.3x. You withdraw the same amount as in scenario #1.
You put it in a regular investment account.
Let’s assume your marginal tax rates are 24% for regular income and 15% for capital gains.
In #1 if you start with $100k then it’s $200k at the time you convert, and you pay $48k (24%) in taxes leaving you with $152k in your Roth 401k. It grows to $198k, you withdraw $152k and you have $46k of gains in your Roth 401k.
In #2 your $100k is taxed and $76k (less the 24%) starts in the Roth. When it’s time to withdraw it’s grown to $198k. Of that, your $76k of contributions are tax and penalty free, leaving you with $122k of gains. To end up with $152k in your bank account you withdraw $115k, paying $28k (24%) in taxes and $12k (10%) in penalties. You have $7k of gains still in your Roth.
In #3 your $100k is taxed to $76k when you earn it, and then grows to $198k. You sell $179k, paying 15% LTCG, and end up with $152k after taxes and $19k still invested (but subject to 15% tax when you eventually sell, so perhaps consider it as $16k).
So you’re better off in #1 than #3 than #2, but the difference between #3 and #2 is relatively small, and this is a scenario relatively unfavorable to Roths.
My claim isn’t “Roth 401(k)s are strictly better than putting the money in investment accounts” or “Roth 401(k)s are strictly better than pre-tax 401(k)s” but instead “when you consider the range of possible futures, for most people Roth 401(k)s are better than non-protected accounts and other protected accounts may be even better”.
The catastrophic error IMO is:
For Roth you mostly can’t take out gains tax-free. The hardship ones are limited, and SEPP doesn’t let you access much of it early. The big ones of Roth conversions and just eating the 10% penalty only work for pretax.
[As an aside Roth accounts are worse for most people vs pretax for multiple reasons, e.g. pretax comes with an option of converting or withdrawing in low income years at low tax rates. More details here.]
You pay taxes on the amount you convert, either from outside funds or withdrawals to you. If you convert $X you owe taxes on that as ordinary income, so you can convert $200k and pay $48k in taxes from outside funds. This makes pretax better.
Re your assumptions, they are not great for an AI-pilled saver. Someone who believes in short AI timelines should probably be investing in AI if they don’t have decisive deontological objections. NVDA is up 20x in the last 5 years, OpenAI even more. On the way to a singularity AI investments will probably more than 10x again unless it’s a surprise in the next few years as Daniel K argues in comments. So their 401k should be ~all earnings, and they may have a hard time staying in the low tax brackets you use (moreso at withdrawal time than contribution time) if they save a lot. The top federal tax rates are 37% for ordinary income and 23.8% for capital gains.
Paying the top federal income tax rate plus penalties means a 47% tax rate on early withdrawals from the Roth vs 23.8% from taxable. I.e. every dollar kept outside the the Roth is worth 44% more if you won’t be using the account after 59.5. That’s a wild difference from the standard Roth withdrawal case where there’s a 0% tax rate.
A substantially larger percentage in Roth than the probability you are around to use it and care about it after 59.5 looks bad to me. From the perspective of someone expecting AI soon this advice could significantly hurt them in a way that the post obscured.
My impression is that the “Substantially Equal Periodic Payments” option is rarely a good idea in practice because it’s so inflexible in not letting you stop withdrawals later, potentially even hitting you with severe penalties if you somehow miss a single payment. I agree that most people are better off saving into a pretax 401k when possible and then rolling the money over to Roth during low-income years or when necessary. I don’t think this particularly undermines jefftk’s high-level point that tax-advantaged retirement savings can be worthwhile even conditional on relatively short expected AI timelines.
Why would money in Roth accounts be so much worse than having in in pretax accounts in the AI explosion case? If you wanted the money (which would then be almost entirely earnings) immediately you could get it by paying tax+10% either way. But your accounts would be up so much that you’d only need a tiny fraction of them to fund your immediate consumption, the rest you could keep investing inside the 401k/IRA structure.
Maybe you want to use the money altruistically? To spend on labor, compute, etc?
Some altruistically-motivated projects would be valid investments for a Checkbook IRA. I guess if you wanted to donate 401k/IRA earnings to charity you’d still have to pay the 10% penalty (though not the tax if the donation was deductible) but that seems the same whether it’s pretax or a heavily-appreciated Roth.
I think a lot of this depends on your distribution of potential futures:
What sort of returns (or inflation) do you expect, in worlds where you need the money at various ages?
What future legal changes do you expect?
How likely are you to have a 5y warning before you’ll want to spend the money you’ve put in a traditional 401k?
What are your current and future tax brackets?
How likely are you to be in a situation where means testing means you lose a large portion of non-protected money?
How likely are you to lose a lawsuit for more than your (unprotected) net worth or otherwise go bankrupt?
The first version of this post (which I didn’t finish) tried to include a modeling component, but it gets very complex and people have a range of assumptions so I left it as qualitative.