Plenty of intermediate investors ask some variation of this question:

“What ratio of Roth to traditional to taxable should I be aiming for?”

After a great deal of study and calculation, I have arrived at the correct answer. The proper ratio of Roth to tax-deferred to taxable is (drum roll, please) . . .

28%:43%:29%

Just kidding. The correct answer is that THERE IS NO IDEAL RATIO. All else being equal, most of us saving for retirement would prefer to have all of our money in Roth accounts. No paying taxes in retirement or even having to file tax returns. No loss of PPACA subsidies. No IRMAA. No RMDs. Your Social Security will be mostly tax-free, too. You might even qualify for some welfare programs despite being a gazillionaire.

However, all else is never equal. It's silly to have all your money in Roth accounts if it means having less money to spend or give in total after tax. And that's pretty much what it means if you have all of your money in Roth.

However, I can give you a semi-useful rule of thumb. Here it is:

Have some Roth money. Have some tax-deferred money. Max out retirement accounts before investing for retirement in a taxable account. Make a decision with every dollar as you go (as far as Roth vs. tax-deferred contributions and whether, how much, and when to do Roth conversions) as best you can, and then let the chips fall where they will and deal with the situation. You get what you get, and you don't throw a fit.

That's it. That's the right answer and as good as I can get as far as a rule of thumb about ratios. There have been times in my life when my portfolio was 100% Roth. A few years later, the tax-deferred accounts were larger than the Roth accounts. A few years after that, the taxable accounts were larger than the tax-deferred and Roth accounts combined. Now the Roth accounts are larger than the tax-deferred accounts. If I had been aiming for some ideal ratio as I went along, I would have made many bad decisions that would have cost me additional taxes and asset protection. Plus, I'd have a whole lot less money saved for retirement because of contribution limitations.

The much harder questions, for which sometimes there is an obvious answer, are whether to do Roth or tax-deferred contributions in a given year (when there is an option to do either) and whether to do a Roth conversion (and how large of one) in a given year. More discussion of these, the most challenging questions in personal finance, can be found in the following post: Should You Do a Roth Contribution?

Some Case Studies for Roth, Tax-Deferred, and Taxable Accounts

Let's do a few case studies and see if we can use this rule of thumb to come up with the right answer.

Case #1 – Minh

Minh is a single 40-year-old doctor with $600,000 in investable assets whose current Roth/tax-deferred/taxable ratio is 40/60/0. He makes $350,000 a year and saves $70,000 a year. He has access to a 403(b) account where he can receive up to a $10,000 1:1 match with a Roth contribution option, but he has no in-plan conversion option, no after-tax contribution option, and no Roth match option. He also has a governmental 457(b) account with no Roth option and no pro-rata issues with doing a Backdoor Roth IRA. How should he save for retirement this year?

Since his 457(b) and his 403(b) match will be all tax-deferred, Minh chooses to have his 403(b) contribution be Roth. He will also make a Backdoor Roth IRA contribution. His savings look like this:

  • $24,500 into the Roth 403(b)
  • $10,000 match into the tax-deferred 403(b)
  • $24,500 into the tax-deferred 457(b)
  • $7,500 into the Roth IRA
  • $6,000 into a taxable account
  • $72,500 total
More information here:

Case #2 – Carmen

Carmen is a 35-year-old partner OB-GYN earning $400,000 per year, and she's married to a sales manager earning $80,000 per year. She has access to a 403(b) profit-sharing plan into which $72,000 can be placed, $24,500 of which can be Roth if desired. Her husband, Carlos, can put $24,500 into a 401(k), and he will receive a 50% match on up to 6% of his salary contributed. Neither plan offers in-plan conversions, withdrawals, nor after-tax contributions. There are no pro-rata issues with doing Backdoor Roth IRAs. They have a portfolio of $220,000 with a current ratio of Roth/tax-deferred/taxable of 70/20/10. They want to save $150,000 this year for retirement. Where should their savings go?

They think they are pretty close to their peak earnings and don't have all that much in tax-deferred accounts, so they've chosen to use tax-deferred accounts as much as possible this year. Their contributions are as follows:

  • Her 401(k)/PSP: $72,000 in the tax-deferred account
  • His 401(k): $24,500 employee contribution into the tax-deferred account plus a $2,400 match from the employer into the tax-deferred account
  • Her Backdoor Roth IRA: $7,500
  • His Backdoor Roth IRA: $7,500
  • Taxable: $40,000
  • Total: $151,500

Case #3 – John and Carol

John and Carol retired last year at age 60 on a nest egg of $4 million that includes $100,000 in Roth accounts, $2.5 million in tax-deferred accounts, and $1.4 million in taxable accounts. Carol plans to claim Social Security at 67, and John plans to claim it at 70. They figure that gives them seven years to do any indicated Roth conversions. Since they have so little in Roth money, they decide to convert $80,000 a year for the next seven years. They will pay for the conversions by selling the highest basis shares in the taxable account. They will live off the dividends plus selling higher basis shares in the taxable account in the meantime.

More information here:

Case #4 – Aarav

Aarav has been very successful in his career, and he is now retired in his early 70s on a nest egg of $12 million with a Roth/tax-deferred/taxable ratio of 20/30/50. He unfortunately lost his wife unexpectedly a couple of years ago. He has plenty of money to live on, but he plans to leave $2 million each to his three children when he dies and to leave the other half of the money to charity. He will be giving some money to the children and charities each year from now until death with a big lump sum at death. He is wondering if he should do any Roth conversions.

The best money to leave to charity is tax-deferred money. It can be given as Qualified Charitable Distributions (QCDs) while you're alive, and then the beneficiary can be the charity when you die. Neither you nor the charity will pay any taxes on the gifts. Since Aarav's portfolio is less than 50% tax-deferred, paying taxes on money that no one ever has to pay taxes on is pretty stupid. So, he wisely decides not to do any Roth conversions. The Roth money plus a significant chunk of the taxable account (which will receive a step up in basis at death) will be left for the heirs. The rest of the taxable account, along with the remaining tax-deferred account after QCDs, will go to charity.

 

Note that nobody in these case studies was aiming for a certain “ideal” ratio of the various accounts. They made every decision as best as they could along the way and just dealt with the situation when it came time to make another decision.

As a doc, you have valuable knowledge and information. Various companies want that knowledge, and they are willing to pay you for it. If you're interested in starting a side hustle as a paid survey-taker while also making a difference in the medical field, check out our favorite physician survey companies today!

What do you think? What's your ratio? Do you plan to do anything to change that ratio? Why or why not? 

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