Morningstar Magazine - August/September 2017 - 17

paying his or her marginal tax rate on a retirement
contribution-the highest rate a worker
pays in our progressive tax code. The tax benefit
on a Roth contribution may be as low as
the effective rate-the weighted average of the
taxes paid on all the tax brackets. It must be
emphasized that the benefits of Roths can be on
the effective rate, depending on the other
retirement income a worker has and how he or
she withdraws income for Roth accounts.
Unlike traditional contributions, Roth contributions
reduce take-home pay by the full amount
of the contribution, as the tax benefit on the Roth

is deferred until withdrawal. In contrast, traditional
contributions reduce a worker's paycheck by
much less, as the worker benefits from immediate
tax savings for federal and, in most cases, state
or local income tax.
To examine the tax-equivalent difference from
a shift to Roth contributions, the following
analysis assumes workers will not reduce their
take-home pay, but will adjust their traditional
contributions according to their marginal
federal tax rate as they shift to Roth. (Because they
vary widely, we do not use state income taxes
for this analysis.)

EXHIBIT 1

Taking a Hit This middle-class worker would see a 7.8% annual reduction of
retirement income if Roths replaced traditional, pretax contribution plans.
Single 30-Year-Old Worker Earning $50,000 Annually (25% Tax Bracket), Retiring at Age

Contribution Rate (%)
Take-Home Pay Reduction (%)
Aftertax Replacement Income Retirement (Incl Social Security) (%)
Percentage Change in Aftertax Income in Retirement from Roth Shift (%)

Traditional

Roth

10.0

7.5

7.5

7.5

61.6

56.8

-

-7.8

Notes: Assumes a 3% real rate of return and a simple 4% drawdown rule applied across all accounts. These examples assume tax brackets remain
the same at 2% inflation, but unindexed parts of the percentage of Social Security income that is taxable are not adjusted, as is current law. This analysis
assumes no employer match or existing retirement savings, and a Social Security benefit of $19,200 in 2017 dollars and an inflation-adjusted standard
deduction and personal exemption in retirement.

EXHIBIT 2

Cushioning the Blow Savers who have access to employer matches and
who have built nest eggs won't lose as much or will gain in a switch to Roths
from traditional plans.
Percentage Change in Aftertax Income From Shift
to Roth Contributions for 30-Year-Old Worker

Annual Income at Age 30
$25,000

$50,000

$75,000

$100,000

15%*

25%

25%

28%**

$12,264

$19,200

$24,516

$27,768

Baseline Case (Using Assumptions in Exhibit 1)

-5.0%

-7.8%

-5.0%

-4.7%

3% Traditional Match

-4.6%

-4.5%

-1.1%

+2.3%

1× Salary Saved in Traditional Account

-4.3%

-2.8%

+0.2%

+2.6%

Marginal Tax Rate (Bracket)
Annual Social Security Benefits

Notes: This analysis uses the same assumptions as Exhibit 1, with changes in income, match rate, and amount of savings in a traditional account.
*This person could also be eligible for a $250 Saver's Credit, which is not factored into the analysis because it could not be received until after the annual
year ended, reducing its effectiveness at helping workers save more.
**For this case, we use a blended rate of 27.4% because the earner straddles the 28% and 25% brackets.

Our analysis shows that middle-class workers
would likely experience the biggest income
losses in retirement from a shift to Roth vehicles.
For example, a middle-class 30-year-old worker
in the 25% bracket earning $50,000 annually could
see a sharp 7.8% annual reduction in aftertax
income in retirement from a shift to Roth
contributions, assuming tax brackets remained
the same ( E XHI B I T 1 ). This example focuses
on a younger worker because those are the ones
for whom the change in tax timing means
the largest changes in eventual income. Of course,
younger workers who greatly increase their
wages might benefit from the Roth, if they end
up with more retirement income than they
had at age 30.
Higher-income and lower-income workers would
be hurt much less than middle-income
workers under a shift to Roth contributions. As
illustrated in E XHI B I T 2 , higher-income workers
have much higher effective tax rates in
retirement, increasing the value of Roth accounts
in the drawdown phase. Lower-income workers
are also hurt less because their tax burden
is quite low during their working lives, reducing
the benefits of traditional contributions. In fact,
many low-income workers may benefit from a shift
to Roth, because they may have no federal tax
burden at all if they are eligible for the Earned
Income Tax Credit or Child Tax Credit during their
working lives.
While our analysis does not use a microsimulation
model (of the type that the Employee Benefits
Research Institute and The Urban Institute
use) to estimate all the likely winners and losers
from a shift to Roth, it seems clear from the
analysis on prototypical savers that many
middle-income people would lose from a shift to
Roth contributions.
Extending the analysis, the deleterious effects of
a shift toward Roth contributions would be
mitigated for workers with employer matches and
for those who have already saved substantial
traditional retirement savings account balances
( E XHI B I T 2 ). The reason is that workers with
employer matches (which we assume will still be
treated like traditional 401(k) contributions)
or with account balances will benefit from their

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