{"id":276,"date":"2022-04-04T12:00:00","date_gmt":"2022-04-04T12:00:00","guid":{"rendered":"https:\/\/moneywithkatie.com\/is-fica-tax-the-key-to-solving-the-traditional-vs-roth-401k-debate-once-and-for-all\/"},"modified":"2025-08-29T16:49:01","modified_gmt":"2025-08-29T16:49:01","slug":"is-fica-tax-the-key-to-solving-the-traditional-vs-roth-401k-debate-once-and-for-all","status":"publish","type":"post","link":"https:\/\/moneywithkatie.com\/is-fica-tax-the-key-to-solving-the-traditional-vs-roth-401k-debate-once-and-for-all\/","title":{"rendered":"Is FICA Tax the Key to Solving the Traditional vs. Roth 401(k) Debate Once and for All?"},"content":{"rendered":"
\n

Is FICA tax the key difference maker in the Roth vs. Traditional 401(k) debate?<\/p>\n

This blog post will hopefully<\/em> be quite a bit shorter than the ironically named \u201cUltimate Traditional vs. Roth 401(k) Debate\u201d post I wrote previously and slightly shorter than the \u201cWill You be in a Higher Tax Bracket in Retirement? Maybe, But It\u2019s Unlikely\u201d post that came more recently. <\/p>\n

Why? Because it\u2019s more of an \u2018addendum\u2019 than a knock-down, drag-out brawl.<\/p>\n

Take a walk with me down memory lane, will you? Previously, I\u2019ve made one primary argument in favor of Traditional. It\u2019s mostly been based on logic that seems ironclad to me:<\/p>\n

When comparing your tax rate in your working years (applies to Roth contributions) to your tax rate in retirement (applies to Traditional distributions), you\u2019re not comparing apples to apples: You\u2019re comparing your marginal<\/em> rate now (likely 24%, depending on how much money you make) to your effective<\/em> tax rate later (likely sub-20% in retirement, depending on how much money you spend). Not only that, but investing in a Traditional 401(k) frees up more investable take-home pay<\/em> because it lowers your tax bill.<\/p>\n

Still, I heard pushback both times from passionate Roth advocates: \u201cBut I\u2019m paying taxes on the seed<\/em>, not the harvest!\u201d They\u2019d argue, poetically\u2014and also completely missing the point.<\/p>\n

If you chop off enough of the seed before you plant it, your harvest is smaller<\/em>. <\/h2>\n

Not only that, who eats their entire harvest all at once? Why not grow the bigger harvest and then pay as you go?<\/p>\n

I thought my reasoning (and the math) made a metric dick ton of sense. In fact, the only compelling argument I\u2019ve really ever heard in favor of Roth is that of RMD<\/a>s: That once you turn 73, the government looks at the size of your pre-tax bucket and says, \u201cAll right, you gotta start withdrawing more (maybe), and paying taxes on it.\u201d<\/p>\n

That event\u2014in which the government may wrest back control and force<\/em> you to use your own money\u2014means you no longer have total control over your tax rate, and it\u2019s a valid criticism (though it\u2019s also one of those problems where you have to admit you\u2019d be happy to have it, if it means you have so much money the government starts making you spend some of it).<\/p>\n

Now that we\u2019ve summarized memory lane and you\u2019re up to speed, let\u2019s talk about FICA taxes<\/h2>\n

What the FICA?<\/p>\n

FICA taxes = payroll taxes = Social Security and Medicare.<\/p>\n

These pesky little buggers take an extra 7.65%<\/a> from your paycheck. You probably noticed it early on in your career when your paycheck was even smaller than you anticipated after taxes.<\/p>\n

And you know what FICA taxes apply to? Employee elective salary deferrals<\/em>.<\/span><\/a> Also known as: Your contributions to your retirement accounts. <\/p>\n

That\u2019s right. You pay 7.65% on your Traditional and<\/em> your Roth contributions to your 401(k), even if your Traditional contributions are exempt from federal and state taxes. Bummer, huh?<\/p>\n

That means your effective tax rate on your Traditional contributions is 7.65%, but your effective tax rate on your Roth contributions is your marginal tax rate + 7.65%.<\/em> <\/p>\n

You thought<\/em> you were paying 24% on your Roth contributions? Think again: You pay 31.65%<\/a>.<\/p>\n

That\u2019s almost a third of your contribution that gets eaten up in taxes if you\u2019re in the common 24% bracket! Take your seed and slice off a third, not a quarter.<\/p>\n

At the outset, this really doesn\u2019t make a difference\u2014after all, the tax applies to both Traditional and Roth contributions, so in a way, it\u2019s like it applies to neither. In the contribution phase<\/em>, its net effect is zero when weighing one option against the other. <\/p>\n

But in retirement? When you\u2019re using<\/em> that money? Here\u2019s the kicker: You don\u2019t<\/em> pay FICA taxes on your distributions. None of your retirement income from your retirement accounts is subject to FICA (payroll) taxes, making your effective tax rate even lower than I thought. <\/p>\n

This revelation originally visited me while writing a podcast episode that referenced a T. Rowe Price analysis that finds the income needed in retirement is around 75% of your income<\/span><\/a> in your working years\u2014it casually noted that the \u201creduction in taxes\u201d retirees experience lowers their expenses. <\/p>\n

I was like, \u201cWait a second, we\u2019re just going to gloss over the fact that this T. Rowe Price whitepaper is tossing in lower taxes as a given<\/em> in retirement?\u201d<\/p>\n

Technically, it\u2019s not the FICA tax itself that makes the difference, but our perception of our post-tax income <\/h2>\n

Since we pay FICA taxes on our contributions on both the pre-tax and Roth options, but pay FICA on neither<\/em> set of distributions, its true net effect is zero. <\/p>\n

But it\u2019s still impactful: Why? Because your own perception of your post-tax income is nearly 8% lower because of FICA taxes.<\/p>\n

Your entire paycheck<\/em> gets taxed with these payroll taxes (and if you\u2019re self-employed, you pay 15.3%\u2014the employer and employee portion) up to $176,100 in 2025, where your social security liability tops out.<\/p>\n

For example, if you make $100,000 per year, your experience of your take-home pay (omitting state taxes) is $77,341. We\u2019ll assume you\u2019re single and this money is just for you<\/em>.<\/p>\n

That\u2019s after you pay $15,009 in federal taxes and $7,650 in FICA taxes.<\/p>\n

Your total tax liability is $22,659. <\/p>\n

It\u2019s natural to look at your experience (take-home pay of $77,341 per year, or $6,445 per month) and say, \u201cI feel like I might<\/em> want to spend more than $6,445 per month in retirement,\u201d and assume that it means you\u2019ll need to withdraw >$100,000 per year in order to do so.<\/p>\n

While the data would suggest that that\u2019s unlikely for a single person (data from JP Morgan Asset Management shows that spending tends to peak in the late forties and early fifties and then decline steadily by 1% per year), let\u2019s assume you\u2019re able<\/em> to spend that much in retirement. <\/p>\n

(I say \u201cable\u201d because\u2014in today\u2019s dollars\u2014you\u2019d need about $2M invested in order to spin off $6,445 per month before taxes.)<\/p>\n

In order to have $6,445 per month in your working years, you had to earn $100,000 because taxes ate up the rest. You paid $22,659 in taxes.<\/p>\n

But in order to have $6,445 per month in retirement<\/em>, you just have to withdraw that amount per month from your 401(k) and declare it as income.<\/p>\n

But you won\u2019t pay FICA taxes on that income, which means you won\u2019t need to withdraw $100,000 to end up with $6,445. You\u2019ll only need to withdraw about $90,400 to pay yourself $6,445 per month and<\/em> pay your tax liability. <\/p>\n

That\u2019s because your tax liability on $90,400 is $12,876, leaving you with about $77,524 to spend \u2013 or $6,460, roughly the same as your \u201ctake-home pay\u201d during your earning years.<\/p>\n

But wait\u2014how did we accrue that 401(k) balance of $2 million in the first place? By saving a portion of that $6,455 each month.<\/em> <\/p>\n

We still have to account for the fact that you weren\u2019t<\/em> spending your full $6,445 per month in your earning years\u2014you would\u2019ve needed to save substantial chunks of it to end up with $2M in your 401(k). <\/p>\n

In this example, we\u2019re controlling for inflation by ignoring it entirely, but the apples to apples comparison is:<\/p>\n

$100,000 of income produces $6,445 of take-home pay per month (some of which had to be set aside and invested) while working and generates a $22,659 tax bill (or an $18,128 tax bill if you were contributing to a Traditional 401(k), which this example presumes you were)<\/p>\n

$90,400 of annual distributions produce $6,460 of take-home pay per month (none of which has to be set aside and saved) while retired and generates a $12,876 tax bill<\/p>\n

See where I\u2019m going with this? <\/p>\n

Thanks to payroll taxes, it takes less \u201cincome\u201d in retirement to produce more take-home pay (and therefore a smaller tax bill)<\/h2>\n

So what about those RMDs? Well, one way to avoid them is by converting your pre-tax funds to Roth. <\/p>\n

\u201cBut wait, shouldn\u2019t we have just started <\/em>with Roth then?\u201d <\/p>\n

Not while you\u2019re making $100,000\/year, honey!<\/p>\n

Why not start converting to Roth and paying your effective tax rate on those conversions as soon as you retire<\/em> when you have no other earned income?<\/p>\n

Realistically, our example above is even more<\/em> dramatic than I made it look, because\u2014as noted\u2014some of that $6,445 of take-home pay would\u2019ve needed to be invested to become $2M. If we work for the average timespan of 40 years and get an average real rate of return of 7%, we\u2019d have to set aside about $900\/mo. to hit $2M in 40 years. <\/p>\n

(Again, ignoring inflation through-and-through for simplicity.)<\/p>\n

That would make our real take-home pay during our working years closer to $5,500, or $1,000 less than our monthly retirement income. <\/p>\n

So even if you DID somehow finagle a way to spend more in retirement, you can spend a full $1,000 more per month in retirement than you\u2019re experiencing as take-home pay now and still<\/em> pay about 30% less in taxes!<\/p>\n

That means if you\u2019re concerned about RMDs, you can just maintain your same $5,500\/mo. lifestyle and convert the additional $1,000 per month to Roth (paying the exact same taxes outlined above, but shrinking your pre-tax bucket and growing your Roth bucket proportionally). <\/p>\n

If our hypothetical example Rich Girl had initially contributed those funds to a Roth 401(k) instead at the same savings rate ($10,800\/year), she would\u2019ve paid her marginal rate of 24% and another 7.65% for FICA: $3,418 in taxes each year, or an effective tax rate of 31 cents per dollar. That money has to come from somewhere, and usually, the money that pays our taxes is money that otherwise would\u2019ve been invested (as savings are more likely than spending to be cut in response to lower take-home pay).<\/p>\n

Instead, you\u2019ll pay $12,876 on the entire $90,400 of distributions ($12,000 being converted to Roth if you\u2019re trying to keep spending consistent and complete some Roth conversions; the other $66,000 being spent), an effective tax rate of 14% (14 cents per dollar). And remember, this example presumes you\u2019re single when you take these distributions\u2014if married, the tax rate is roughly half that. Even better news for those who are earning the $100,000 single and spending it in retirement while married. <\/p>\n

The FICA payroll taxes we\u2019re accustomed to (and the fact that we\u2019re saving part of our income) distort our perception of how much we really need<\/h2>\n

Paid non-client of Betterment. Views may not be representative, see more reviews at the <\/em>App Store <\/em><\/span><\/a>and <\/em>Google Play Store<\/em><\/span><\/a>. <\/em>Learn more <\/em><\/span><\/a>about this relationship. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional.<\/p>\n

Hypothetical examples are for illustrative purposes only, not attributable to any specific portfolio\u2019s performance, and should not be utilized when making a specific investment decision, as actual performance may vary depending on your unique circumstances and factors not necessarily accounted for here, such as market volatility, inflation, advisory fees, reinvestment of dividends or earnings, rebalancing, or tax-saving features, etc. All performance, events, persons, and results described herein are entirely fictitious.<\/p>\n

Any links provided to other websites are offered as a matter of convenience and are not intended to imply that Betterment or its writers endorse, sponsor, promote, and\/or are affiliated with the owners of or participants in those sites, or endorses any information contained on those sites, unless expressly stated otherwise.<\/em><\/p>\n

A $100,000 salary in our working life and $100,000 in distributions from our retirement accounts aren\u2019t created equal.<\/p>\n

And remember, just because you don\u2019t invest in a Roth 401(k) doesn\u2019t mean you can\u2019t invest in a Roth IRA<\/em>\u2014but that\u2019s why I like utilizing the $23,500 of available pre-tax investment \u201cspace\u201d to generate some tax savings, and then invest my next $7,000 per year in a Roth IRA. Two birds with one stone: Pre-tax contributions create more investable income, and contributing to both types of accounts creates more flexibility in tax planning later.<\/p>\n

You can open and invest in a Roth IRA with Betterment<\/span><\/a>. Simply answer a few questions about what you\u2019re investing for (if it\u2019s a Roth IRA, you\u2019ll go down the \u201cInvest for Retirement\u201d path). You can even set up a semi-monthly cash transfer from your checking account after pay day.<\/p>\n<\/div>\n","protected":false},"excerpt":{"rendered":"

Is FICA tax the key difference maker in the Roth vs. Traditional 401(k) debate? This blog post will hopefully be quite a bit shorter than the ironically named \u201cUltimate Traditional vs. Roth 401(k) Debate\u201d post I wrote previously and slightly shorter than the \u201cWill You be in a Higher Tax Bracket in Retirement? Maybe, But […]<\/p>\n","protected":false},"author":178814,"featured_media":2427,"comment_status":"closed","ping_status":"open","sticky":false,"template":"si-template-single-post-401-k-s-and-iras.php","format":"standard","meta":{"footnotes":""},"categories":[37,35],"tags":[47,57],"class_list":["post-276","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-financial-independence","category-investing-and-taxes","tag-401ks-and-iras","tag-popular-401ks-and-iras"],"yoast_head":"\nIs FICA Tax the Key to Solving the Traditional vs. Roth 401(k) Debate Once and for All? - Money with Katie<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/moneywithkatie.com\/is-fica-tax-the-key-to-solving-the-traditional-vs-roth-401k-debate-once-and-for-all\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Is FICA Tax the Key to Solving the Traditional vs. Roth 401(k) Debate Once and for All? - Money with Katie\" \/>\n<meta property=\"og:description\" content=\"Is FICA tax the key difference maker in the Roth vs. Traditional 401(k) debate? 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This blog post will hopefully be quite a bit shorter than the ironically named \u201cUltimate Traditional vs. Roth 401(k) Debate\u201d post I wrote previously and slightly shorter than the \u201cWill You be in a Higher Tax Bracket in Retirement? 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