All the Roth vs Traditional 401k calculators are wrong!

[David Kirkland]

I was trying to find a calculator online to compare a Roth vs Traditional 401k (or IRA). I found several, but they all seem to be making the same fundamental mistake. I am posting this finding here to see if anyone can point out the flaw in my logic or otherwise confirm that the online calculators are making false comparisons.

Roth
$7,333 (income) - 25% (tax) = $5,500 (invested)

Traditional
$7,333 (income) - 0% (since its pre-tax) = $7,333 (invested)

In both cases it costs me $7,333 gross, so from the investors standpoint these are equivalent.

However, the calculators don't do it this way.  They compare contribution amounts, which are not equivalent from the investors standpoint because one is pre-tax and the other is not.  By using the same contribution amount the calculators are really only comparing compounding interest.  They are ignoring the fact that the Traditional contribution equivalent to a $5,500 Roth max contribution comes pre-tax, so there is more to compound against.  To truly compare apples to apples we would need to compare a $5,500 Roth contribution to a $7,333 Traditional contribution (assuming 25% tax).

Why don't the calculators account for the "gross cost to me"?

What's the point of comparing two investment vehicles when the values used are not equivalent?

What am I missing here?

Thanks in advance for your insights.

[David Kirkland]

For anyone that finds this thread in the future, the concern I outline above doesn't really matter because the investment will grow as a percentage.

For example, let's say you invest $1...

Traditional (pre-tax)
Investment doubles = $2
$2 taxed at 25% = $1.5

Roth (post-tax)
$1 taxed at 25% = $.75
Investment doubles = $1.5

Thus, the real difference comes from the differential between the current tax rate and the future tax rate.

Higher future tax rate?  Pay the tax now (Roth).

Lower future tax rate?  Defer the tax (Traditional).

Obviously the compounding interest and tax strategy are not the only considerations, but I hope this helps someone.