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Roth or Traditional When You Have Student Debt?

A reader hit me up recently and really wanted to know if I thought he should choose a Roth or Traditional account for his retirement savings. This is a hard decision even if you have no student debt. However, it's made out to be an easy one, with tips from friends, relatives, and even late night PBS broadcasts.

For those who don't know, you can save for retirement with two different types of accounts. A Roth account allows you to pay taxes now, and when you retire your withdrawals are tax-free. A Traditional account gives you a tax deduction now, but you must pay income taxes on withdrawals down the line.
We'll weigh the pros and cons of each option when you have student debt. Usually the best choice defies conventional wisdom.

Here's What the Reader Asked About Roth vs Traditional

I'm intrigued by one particular aspect of your post regarding the Top 40 things to know about PSLF. Specifically, reducing AGI and getting “indirect matching” on pre-tax retirement contributions.
I like this idea and am thinking about sending more money into the pre-tax realm, but can you comment on how this plays out if someone with low income now and higher expected income later (like your wife or myself = doctors, specifically residents) has the opportunity for post-tax retirement investment such as a Roth 401(k)? I'm already maxing out my Roth IRA so I'm specifically asking about the Roth 401(k), although I think, for the purposes of this, they are interchangeable.
Say I make $60K/yr as a resident. This puts me in the 25% tax bracket.
$100 post tax = $133 pre tax (roughly, with the understanding that the tax bracket is not flat but tiered – maybe you know a better way of comparing these)
I tried using various online calculators to do the math to show the difference between putting $133 in a pre-tax account (or even $136, as the ‘extra' $33 reduces my AGI and decreases my loan repayment by 10% = 3.30, and 133+3.30 = 136) versus $100 in a post-tax but can't find a good one to calculate the taxes at withdrawal.
Sorry if this makes no sense, but can you see where I'm going? Should I invest pre-tax now and reduce my AGI to reduce my loan repayment, or should I invest post-tax, pay a bit more on my loan but “save” by limiting my taxes at withdrawal when I expect to be at higher tax bracket.
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My First Rapid Fire Thoughts

The real question here is what happens if you're rich and have to pay a lot more in taxes than what you paid as a resident.

Another point: the reader makes a mistake with the math in terms of how it affects the loan repayment. If the reader took $100 and put it  into a pre-tax retirement account, then he would have to pay $10 less on his loans the following year. What you contribute to Traditional retirement accounts lowers your income for the current calendar year.
That means if you saved the maximum $19,500 in your Traditional 401k, your student loan payment would be reduced by $1,950. When would that happen? The next time you certify your income and produce a tax return with lower AGI. It's confusing, but loan servicers tend to use your taxable income from the prior year to determine your income driven repayments for the coming year.

With PSLF, the Retirement Answer is Obvious

If you're going for Public Service Loan Forgiveness, the Roth account almost never makes sense. 99% of borrowers doing PSLF should be exclusively using a Traditional account because you want the tax deduction now.
Our resident doctor was “only” in the 25% federal tax bracket. However, most resident programs are located in higher tax areas with a high cost of living. That means out reader is probably not deciding where to put his next $15,000, but more like his next $5,000.
Let's assume his state charges 5% income tax. Now we're up to 30% that he's saving in taxes for each $1 of contribution to a Traditional retirement account.
However, as I mentioned, each dollar saved also reduces his loan payment by 10 cents. So that's like a 10% tax savings in the form of lower student loan payments. This 10 cents is a taxable amount, so it needs to be grossed up for taxes. Hence, it's probably more like 13 cents for each dollar saved that you get back in the form of lower student loan payments.
In that case, the marginal savings of our resident contributing to a Traditional account is about 43%.

But I'm Gonna Be Rich, Why Won't You Let Me Use the Roth?

The vast majority of doctors are not in a 40% bracket in retirement when they're pulling out RMDs at 70. Like probably over 90%.
Even so, most physicians have to go to the complicated step of doing a backdoor Roth IRA because they're over the income limits.
Heck, many never retire period!
You're protecting against downside risk in retirement when you save in a Traditional account. If you're going for PSLF, you should really focus on building assets and protecting against the worst case scenario, which is you having to work forever.
Maybe you could say taxes are going up and that's why you want to use a Roth. If so, then the reward for charitable contributions would go up too. You can currently contribute much of your required IRA distributions to charity and deduct it unless you're Mitt Romney. And if you're that rich, then you have bigger problems to worry about.
If you did end up poorer that you thought you'd be, you'd better hope you took the deduction early and saved more with the Traditional.
The way I look at it is downside protection. Most people save almost nothing relative to their incomes (professionals included), and those folks need to drastically increase pretax before they even think of a Roth 401k.
The Roth vs Traditional retirement account discussion is something I try to talk about during my consult service. Feel free to contact me and ask more details about your specific situation.
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  1. John Si February 20, 2020 at 3:35 PM

    If someone is in PSLF, can they do traditional and then convert to roth after residency? Would you recommend this?

    • Travis at Student Loan Planner February 20, 2020 at 7:05 PM

      You could but I would probably wait to convert til after PSLF otherwise the conversion would show up in your AGI and thus your student loan payment

  2. Jenna Klein July 21, 2020 at 11:17 AM

    Hi Travis,
    I really appreciated your 40 PSLF Tips article as well as this one.
    I’m wondering whether I should go traditional “all the way,” as in traditional IRA and traditional 403b, or traditional IRA and Roth 403b afterwards. My 403b has a quarterly fee of $5 though!
    Both myself and my partner are interested in this – 59K no state income tax, and 60K with 4.75% state income tax.
    Thanks a bunch Travis!

    • Amy at Student Loan Planner July 29, 2020 at 8:16 AM

      You can’t go wrong either way, so long as you’re saving for retirement and investment planning. If you want an in-dept plan, a consult with one of our consultants can give you clarity based on your financial picture and future goals.

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