Help me understand this shower thought I had.
My thesis is that a Roth IRA is superior to a trad IRA when you’re young. Let me expose this case.
A young person, Sam, enters the workforce and decides to save for retirement for 10 years, then let his money grow with the power of compounding. He contributes $7k per year for 10 years. He’s now 26 with a $70k IRA. By age 66, assuming his money doubles every 10 years, he will have $1.12M. With this scenario, he wonders what kind of IRA would minimize his tax liability.
Trad IRA:
Let’s assume Sam is a high-paid professional in the 32% tax bracket. Placing $70k in his Trad IRA has saved him $22.4k in taxes.
At age 66, he retires and has a $1.12M nest egg. At 4% safe withdrawal rate (let’s forget about RMDs here for a sec) that’s $44.8k per year withdrawn from the account and taxed as taxable income. With an effective tax rate of 5.43%, Sam pays $2.4k per year in taxes. This means in 10 years he will have paid $24k in taxes. He will realistically live until 80, and with RMDs kicking in, upping his withdrawal rate, he will have paid closer to $40k in taxes before he passes.
Roth IRA:
The calculations here are a bit simpler. Sam stops saving $22.4k in taxes from the $70k in contributions to his Roth IRA. Nonetheless, his money now growths tax deferred and can be withdrawn tax-free. He will not pay any more taxes.
Conclusion:
It seems like a Roth IRA is a no brainer at a young age. Even at high tax brackets such as 32%, and without worst-case scenario assumptions such as tax hikes in the future, the traditional IRA approach underperforms the Roth approach.
Given this, I am curious why the general consensus is to recommend traditional accounts for people on high tax brackets and Roth accounts to lower paid individuals. Shouldn’t age be taken into account as well?