More Roth vs. Traditional 401k/IRA Data: Historical Marginal Tax Rates vs. Median Income

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In my Roth or Traditional 401k decision process, I chose the Roth for the rest of this year. This essentially means that I’d rather pay up to 28% of tax right now on my contribution rather than pay whatever the going rate will be 30+ years from now. But why? I’m have relatively high income right now – Shouldn’t my income in retirement be less if I really want to be a beach bum? Probably, but here’s why I think 28% is still a pretty good deal based on history…

Having to guess what tax rates will be 40 years into the future is a daunting task! So let’s start by looking 40 years in the past. From 1967 to 2005, I found the both the median household income and the 95th percentile income from the U.S. Census Bureau. I chose these to roughly represent “middle” and “high” income levels.


As you can see, both grow with time. (Yes, the gap between them is increasing. Let’s sidestep that hot potato right now.)

Next, I found the corresponding marginal tax rates that such incomes would have paid each year. Since we are looking at households, I used the tax information for the Married Filing Jointly status as an approximation. I ignored things like standard or itemized tax deductions across the board to keep it simple. With this information, we can roughly see how the marginal tax rates have changed over time, while still adjusting for the gradual increase in incomes:


Results and Conclusions
We are currently experiencing some of the lowest marginal tax rates in recent history. The average marginal tax rate for a median, or “middle income”, household from 1967 to 2005 was 33%. The average marginal tax rate for a “high income” household was 44%. Today, we are only at at 15% and 28%, respectively. Assuming that today’s tax rates will continue on for the next 20, 30, 40 years may not be the best idea.

Will they get even lower? Or even flatten out? I don’t think so. Considering the historical rates we say above, and combining that with our continuing government deficits and the prospect of a nationalized health care system, I personally find it unlikely that in 2047 my marginal tax rate will be lower than 28%, even at median income levels. What do you think?

To be sure, this is a very simplified analysis. I am not even looking at total tax rates, just marginal ones for the express purpose of directing my IRA and 401k contributions. If you know of a better study done elsewhere that I missed, please do share.

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  1. Wow, I guess that means you expect 200K in investment income a year in retirement. You better get to saving.

  2. I like your mention of “the prospect of a nationalized health care system.” I wonder how many people would rather have that than social security.

  3. The problem I see with this analysis, however, is that the tax regime 40 years ago is vastly different than it is today. The *nominal* marginal tax rate may have been 60+%, but the effective tax rate was much lower. Those who were subject to that rate could probably afford advisers to help them exploit the loopholes that the Reagan administration attempted to close in 1986. I’d be interested to see what the effective rate was (total tax paid divided by total income).

  4. Ted Valentine says

    1. Why is SS and Medicare tax never considered? Do you have to pay that regardless? Is Roth IRA income taxed for SS and Medicare? Certainly those rates are going to go up.

    2. It seems to me that the only compelling reason to exclusively do a ROTH IRA and 401k would be if you have substantial taxable assets right now or will inherit a lot of money. If the bulk of your wealth is in ROTH accounts at retirement then your tax rate at retirement is going to be substantially lower. Then you might as well have just used the traditional IRA and avoided the high taxes now while you have a great salary. For this reason I like the idea of splitting it up between Roth IRA/401k and traditional IRA/401k so you have flexibility in the future.

  5. Apparently tex does not understand the power of investing early on.

    My wife and i ALWAYS spent less than we earned and it truly will make a difference for your family.
    I think that the roth is a great vehicle for the people starting out early.
    That dollar invested in a roth can grow tremendously in 25 or 30 years.

  6. We started contributing to a roth401k this past January, prior to that it was a standard 401k. Out of 40+ people eligilble to participate in our company my wife and I are the only ones taking advantage of it. I guess that either makes us genius or the village idiot–I’m hoping for the first!

    Like Jonathan when we retire we very much plan to shift into a different gear and do expect our tax rates slide a bit. For those that think the tax rate can’t go up just go back 100 years and look up the rate 😉

  7. Good graphs, but aren’t you essentially “market timing” only with taxes? You are passing up on the certainty of lowering your taxes today in exchange for the less certainty of lowering your taxes in the future.

  8. I have to agree with Travis. For the young the power is less in the tax savings now, but much more in the fact that the growth is entirely tax-free. So if you have a long investment horizon, and think about compounding, you can see how lucrative a ROTH option is.

    I am only 30 and we are all in ROTHs now (no brainer since we are only in 15% tax bracket anyway).

    I am a CPA and I also notice most of my clients are not in lower tax brackets in retirement. You lose most of your tax deductions once you hit retirement (mortgage paid, kids grown, no tax-deferred options with no earned income, etc.). People who plan hard for retirement or are successful in their careers generally do not find lower tax brackets, though it is spouted all over the internet that your taxes will go down in retirement (be careful there).

    I also feel like taxes have been coming way down in the last decade I have been practicing as a CPA, but tax breaks are skewed more to certain groups (homeowners, families, investors, business owners, etc.). I have not really been in the business long enough to give a long-term answer. AMT is brutal too.

    Do I truly believe I will be able to withdraw all this money tax-free in retirement? No, the tax law will change. But probably not retroactively, which is all the more reason to get as much into ROTH vehicles while we can. I don’t know when the tax law will change. But the government is already in trouble enough without letting us 20/30-somethings withdraw our entire retirement tax-free. 😉 It’s just not sustainable for the long haul. I say it enjoy it while it lasts.

    By the same token some of us may be better off taking the certain tax break now. But I think in an odds game the ROTH is a better bet. Then again people in the 60s/70s were betting that tax rates would rise. I am more on the fence when it comes to higher tax brackets. I’d probably do 1/2 ROTH, 1/2 traditional, just be squarely in both scenarios. Just don’t have that crystal ball…

  9. Is inflation accounted for or no?

  10. i still dont get from what you can say 28% is a good deal based on history, you then show the history and it is a downward slope, nothing showing it is going up.
    anyway, i agree with teri, right now i am maxing roth ira and tsp, but if i couldnt i would be doing each 50/50. considering how safe people usually want to be with their retirement $, it’s surprising to see them take a ‘gamble’ and pick only one usually. now, i realize in your case you’re talking roth or trad 401k and you can only have one for that job, so for the other spouse’s job or later career i’d pick the other.

  11. Effective average tax rates does not matter for the decision of whether to invest an additional dollar in Roth. The marginal rate DOES matter.

    28% is historically low, but let’s remember that the reason the marginal rates were lowered without a reduction in revenue is that the base upon which taxes were levied was increased. Elimination of beneficial tax treatment of real estate tax shelters and other such tax subsidies permitted Congress to lower the rate.

    If one were to look at the current largest “tax expenditures” (see GAO report GAO-06-1028T entitled ‘Individual Income Tax Policy: Streamlining, Simplification, and Additional Reforms Are Desirable’ which was released on August 3, 2006. ), the largest such areas exempt from tax are, in size order: employer provided health care, the home mortgage interest deduction, employer’s pension contributions to employees defined benefit plans, the exemption for state and local taxes paid, and the capital gains exclusion on home sales. While we can quibble about one or the other of these policies, the are still existing because they are sacred cows.

    Broadening the base further is very difficult. Therefore, rates will not be coming down much further. But the needs of government will grow, as the population ages and medical care and SS expand rapidly. The government will need higher taxes in the future, or it will need to rein in its commitments.

    Ironically, the Roth’s attraction to taxpayers is the mirror of its attraction to budgeteers in Washington. Taxpayers pay the tax now on their income, and pay non later. For budgeteers, who want the money today to help with the budget, this is good. Look at the budget scoring of every Roth retirement item in the last 10 years. They all are scored as raising money for the government.

  12. I disagree that the roth is necessarily better. As shown in the last couple of days, the growth over time is identical. A missing component I see is the effects of globalization. I think we’ve been pretty highly paid in the US and much of the rest of the world hasn’t been. I think the value of work is being equalized globally, and the us represents something like 5% of the global population, but like nearly 50% of resource utilization and GDP. We can see it in the manufacturing industry, call centers, automobiles, etc. Americans aren’t competitive at the wages we currently get. So, which is more likely, that businesses globally will raise the wages of 95% of the globe to meet our standard of living, or that the 5% of us here will have lower incomes? I really think wages will drop as globalization continues and that my income will decrease and I’ll fall into lower and lower tax brackets (assuming they’re not redefined). I figure this will be in the next 15 to 20 years. So, while I do have a Roth IRA too, I’m mainly using the my 401(k) to reduce my taxes now and to sock away as many dollars as possible. It has the additional benefit of that I know exactly what I’m saving today and not trying to guess what the future may hold. Your median data also seems to indicate this, as while the dollar amount of median income goes up, at least since 2000, inflation has been more. From my own personal data, I know my raises haven’t kept up and I’m effectively earning less now that I was in 2000 or 2001. I’m a little better off because of the tax cuts, but overall I’m still worse off now. That’s the trend I think will continue, along with milk getting more expense, and also gas, meat, insurance, healthcare, education, and so on. If I can afford to save more now, take a guaranteed tax break, and save money earlier to take advantage of long term compounding, that seems much better than to guess what tax rate I’ll have in the future, or what my income trend will be, or what inflation is doing.

  13. “Wow, I guess that means you expect 200K in investment income a year in retirement. You better get to saving.”

    1.) 200k/year in retirement for 2 people is not much (we are talking about 200k in 2040 dollars here – at 2% inflation/year we are talking about 100k/year in today’s money). I sincerely hope you will have at least 200k to cover your expenses. My wife works at a not so nice nursing home, and the residents there pay $7500/month per person for skilled nursing care. That’s 85k/yr per person in today’s dollars. Getting old is expensive.

    2.) Three letters – AMT. Contributing to the Roth is a good plan – stick with it.

  14. Keep in mind, inflation will take a chunk out of those future tax bills.

    If you’re in the 25% or low 28% tax bracket, I say get the best of both worlds. Example:

    Putting $15000 into a Roth 401(k) means you spend $18750 at the 25% bracket.

    Putting $15000 into a traditional 401(k) gives you a $3750 tax break. Here’s the trick. Instead of giving that money to GWB to spend on bombs, put that money in a Roth IRA.

    Invest monthly at an average return of 8% for for 30 years and you have $1,849,370.18 in your traditional 401(k) and $462,342.54 in your Roth IRA.

    If you’re in the same tax rate at retirement, you net the same amount with either method. But the my method has two distinct advantages:

    1) you pay less tax with future dollars.
    2) you have more flexibility having both accounts available in retirement.

    Estimating an unknown like the tax code 30 years from now is no exact science. I prefer to know that I’m saving money on taxes now, with today’s dollars.

  15. Matthew Ropp says

    I have a question. If you contribute to a ROTH 401k are you still able to contribute to a ROTH IRA in the same year?

  16. I find these questions incredibly complicated. I don’t think the question is about $15,500. If you are in the 28% tax bracket, then aren’t we are really talking about $21,527?
    Case 1) Start with $21,527 in earnings. Pay $6,027 in income tax. Put the rest (i.e. $15,500) into an Roth
    Case 2) Start with $21,527 in earnings. Put $15,500 into a pre-tax 401(k). That leaves you with $6027. Pay $1.687 in income tax. Take rest (i.e. $4,340) and invest it.

    When you retire, what gives you more money? Heck if I know, but it seems that you should start with your earnings before any taxation is considered.

  17. There are so many people who are going to rely on SSN/Medicare as their sole means of survival. The only way for the government to cover the costs is to raise taxes. I doubt I will see any of the money that I am contributing to SSN. I’ve been maxing out my SEP (pre tax 44 thousand last year). Because I will have “fully funded” my Retirement account (I expect to have between 5-10 million) when I am ready to retire I am sure someone will create a law the “phases” me out of my SSN benefits completely because I am withdrawing too much each year.

  18. Paul is right that you have to consider the money you save in taxes when comparing which is better (Roth vs Traditional). If you invest in a Roth your paycheck/income is smaller. If you go Traditional, your paycheck/income is higher.

    Technically if you make a certain amount of money (I’ve read there’s a line you cross that’s around $150K) then you’re better off getting the tax break now and going with Traditional retirement plans. But that’s only if you invest the tax break you get and leave it untouched until retirement! And most people DON’T. You just spend the extra $150 or so that comes in every paycheck. And even if you did save it, it’s extremelly unlikely that you’d leave it untouched earning stock market rates of return into retirement. You’d probably spend it on a vacation, a car, tuition, or some other shorter term financial goal.

  19. I don’t understand, MEG. I’ve always heard about investing the tax break, but I can never make the numbers show where this “free money” comes from. The way I get a tax break is by not receiving income and placing it in a 401k that I’m not supposed to touch.

    For example, if we assume that I make $30,000 and I want to save 20% of my money for retirement and I’m somehow in the 25% tax bracket (just for illustration).

    For the traditional 401k, I start with $30k, put $6k into the 401k and I’m left with $24k taxable. @ the 25% bracket, I pay $6k in taxes and get $18k after-tax net income.

    For the Roth, I have my $30k and it’s all taxable, so I pay $7.5k and end up with $22.5k after-tax. I take my 20% of this, or $4.5k and invest it in a Roth IRA. I’m left with $18k.

    In both examples, I have the same $18k to pay for rent, transportation, food, internet access or whatever. By the logic I keep hearing about re-investing the tax savings, I should somehow have another $1,500 that I didn’t pay in taxes available to me to invest. But I don’t have that because I didn’t just get to pay lower taxes, but I receive less money as it’s redirected into a 401k account.

    I’m not sure this example works for real-world since I’m not sure exactly where the breakdown is that you drop to a lower tax bracket. I guess in that case, you might have a little more. In my own experience, my 401k contributions haven’t been enough to drop me to a lower bracket, so a consistant percentage for that calculation is appropriate even though there’s $1,500 real value difference in the example.

    I guess I did my budget backward, because I tracked my expenses, figured out, for the example, that I needed $18k/year to live on and chose the 20% investment rate from there. But I don’t see how there’s this idea of extra money to invest if I chose to go with the 401k over the Roth IRA. My limit is still the $18k, not $16.5k if I decide to do a 401k because I save an amount of taxes. Am I missing something obvious?

  20. I think both have their uses, though admittedly I would likely place more into my Roth IRA if it weren’t for my employer match. I think much of the reason people put so much into their 401ks is the added incentive from their respective employers.

  21. reply to Paul says


    I think you’re on the right track, but you don’t finish the equation. You then have to analyze what happens in retirement.

    Here is your quote:

    I find these questions incredibly complicated. I don?t think the question is about $15,500. If you are in the 28% tax bracket, then aren?t we are really talking about $21,527?
    Case 1) Start with $21,527 in earnings. Pay $6,027 in income tax. Put the rest (i.e. $15,500) into an Roth
    Case 2) Start with $21,527 in earnings. Put $15,500 into a pre-tax 401(k). That leaves you with $6027. Pay $1.687 in income tax. Take rest (i.e. $4,340) and invest it.

    So you start as:
    Case 1) $15.5k in Roth
    Case 2) $15.5k in Traditional & $4.34k independently invested

    Now, let’s say you retire in 30 years, and your investments grow at 8%

    Case 1) $15.5k in Roth x (1.08)^30 = $155k
    Case 2) $15.5k in Trad x (1.08)^30 = $155k &
    $4.34k x (1.08)^30 = $43.4k

    Now, when you take it out, you don’t get taxed for Roth, but do get taxed for Traditional (you assume at 28%) as does your independent investment (let’s assume capital gains at 15%)

    Case 1) $155k in Roth –> $155k after tax
    Case 2) $155k in Trad x 0.72 (28% ordinary income) = $111k
    $43.4k x 0.85 (15% cap gains) = $36.9k

    So for total:
    Case 1) $155k
    Case 2) $147.9k

    So you end up with more money at the end with the Roth (this is because you can effectively put more money in a Roth). Now if your tax rate in the future is different, this changes the calculus, of course. But as this post predicts, it likely will not be much lower than 28%, given that tax rates right now are at an all time low.

  22. I like Paul’s outlook on the situation. Chances are good we can all do our own guesstimates on the end game or even simulate these kinds of things in any number of financial calculators that are likely out there to calculate these things.
    Getting to the question at hand I have no idea whether the marginal rates will go up or down but I am sure most readers will be surprised to find out that government tax receipts actually go up as the marginal rates go down. So ironically as the Gov runs out of money it would be counterproductive to raise the rates! Before everyone starts yelling at me that this isn’t possible I know there is a tipping point out there where it goes down as the rates go down, but as yet we haven’t yet reached that point. For all we know it could be as low as 10% for the 95th percentile… who knows.
    Another point for consideration is that we might not have any income taxes at all in the future but rather a consumption tax — for those interested in the concept it’s quite well explained in The FairTax Book.

  23. Ted – You don’t have to pay SS/Medicare on IRA/401k withdrawal, because it is not earned income. Just like you don’t have to pay SS/Medicare on capital gains and dividends.

    Heather – It’s also a gamble to just take your tax break now, and be subject to unknown amounts of taxes later! We are gambling either way, it’s not a matter of market timing, as we have to judge which one is more likely. There is no passive alternative.

    Re: Splitting between them – I also like splitting up the Roth/Traditional Mix, especially as ones’ tax bracket changes. I’m sure I’ll have a little of both. I only get a regular 401k option in my job anyways right now.

    Paul and ReplytoPaul – As long as you’re comparing equal pre-tax contributions and constant tax rates in and out, the Roth will always beat the 401k + Investing the tax savings. This because with the Roth everything is tax-advantaged, not just part of it with the 401k + taxable combo.

  24. I prefer the Roth fro teh following reasons:

    Call me an optimist, but my hope that is by the time I’m retired I’m in a higher tax bracket – not a lower one, meaning I have more income.

    Call me a pessimist, but the Republicans and Democrats have borrowed like drunken sailors, in the future we will have to service that debt which makes me believe that taxes are bound to go up not down. The parties did not cooperate to make social security or medicare solvent that we will need to pay for that too. Add on top of that the likelyhood that the Democrats will promise goverment subsidized healthcare and I don’t forsee how taxes are going to be lower or the same in the future.

    If you pay taxes today its a sure thing, if you plan to pay them in the future the rate is uncertain.

    Roth IRA earnings are tax free so if you hit a home run with your investments, that growth is all extra gravy that you don’t pay taxes on.

    That being said, I think its wise to max out both your Roth IRA and Traditional 401(k) (my work doesn’t even offer a Roth 401(k)). I also think its wise upon leaving a job to immediately convert the 401(k) to a Traditional IRA (better estate planning, more investment options). If you can afford it and qualify MAGI-wise, its worth looking at converting the Traditional IRA to a Roth IRA. Although there are valid arguments that because the tax rate of the future is uncertain diversifying between Roth and Traditional is a good hedge.

  25. What everyone ignores with these calculations is that some tax deductions can be *controlled* by planning to increase later in life. For example, here in coastal California, housing is so ridiculously expensive that it makes no sense to buy a house right now (plus the market is collapsing hard). A person/family can save both for a house and more toward retirement by maxing out Roths or 401Ks now, and buy later.

    If we do buy a house later in life we won’t have paid off the loan by retirement and could still have the interest deduction. Alternatively, if you’ve got $1M-$5M in retirement accounts there’s no harm in keeping a mortgage until you are 90 years old.

    People fall into 2 classes: 1) the “cash constrained” — need as much money as possible to meet short term goals, and 2) the “cash optimizers” — have all current needs/desires but want to maximize profit/lifestyle.

    In my opinion a cash constrained persion is totally nuts to pass up the immediate tax break of an IRA/401K in favor of a Roth. No one can predict the future and the immediate tax break means a better life now as well as an *adequate* retirement fund. Got to hike up mountains and ride motorcycles while you’ve got the strength…

    In our case I’m using both the 401K and Roth IRAs to shelter as much money as possible. The Roths are more conservative than the 401K because we might want to withdraw some money before retirement. This also leaves us well positioned to take advantage of the future real estate situation, should it change in the way I expect.

    Plan your life around all your financial goals, not just retirement.

  26. For those interested: Historical Effective Tax Rates

  27. I don’t disagree about the Roth being a better idea if the in and out tax rates are the same, but I don’t think it is that simple. In retirement I won’t need as much money as I make now. I may not be paying for Social Security, for a house, for kids. In addition, the tax I pay on the money I withdraw won’t be at the marginal rate at which I put my money into the plan. I might make enough in retirement to reach the marginal rate of 25 or 28%, but I’ll get the standard deduction and use of the 10% and 15% brackets. So the percentage of the withdrawal I pay in taxes may be lower. Of course maybe with a pension and my non-retirement assets, I might already be at the 25% or 28% marginal rate when I withdraw my IRA (traditional or Roth), but…. I don’t know. By the way, I do use the Roth when I can, so I guess I’m being optomistic that I’ll have lots of income in retirement, but I don’t know for sure.

  28. In reply to the reply to Paul we have to remember that your upfront tax rate for retirement savings is usually budgeted at the margin, but I think it should really be budgeted at the effective rate paid (why do we always want to penalize our retirement investment more than we would your other expenses — isn’t the first rule to pay yourself first??).
    At the back end since the witdrawals will likely be the bulk of your taxed income at retirement age, it’s also better to budget at the expected effective rate and not the marginal rate across the entire sum.
    I know this doesn’t change the answer since your best guess of the future effective rate is the current rate, but it’s food for thought nonetheless.

  29. I’m having a hard time deciding what to contribute to trad. 401k vs roth 401k at my employer. Right now I am doing 10% to trad. (amounts to $15k/year). I am thinking I need to do a tax diversification and more evenly distribute between trad. and roth 401k. I could effectively drop trad. to 6% and then do 4-5% in roth 401k and still be under the $15,500 cap. But this would increase my taxable income quite a bit. Any tips or suggestions?

  30. I did my own rudimentary comparison with Roth vs. the Traditional (401ks), based on an income of $50K, just to get an idea, and the results were identical if two things held; your after-contribution take home pay is the same, and your tax rate now and in retirement is the same. I also figured (for simplicity) a straight tax rate of 20% (just to be really simple), because this would actually give even more favor to the Roth income.

    If you made $50K and socked away $10K in your regular 401K, you reduced your income to $40 and should go home with $32K.

    If you took your income first, you would have $40K left over, and to be even with the traditional guy, you could only invest $8K in your Roth.

    Given identical yearly returns, these numbers will always be 20% apart (the tax amount). So I don’t understand how the Roth beats the traditional in this regard. In your post, you give the reason if we really believe that income taxes will be higher in retirement than now. I don’t think that has been historically shown either. What I’ve noticed is that the taxes have shifted onto real estate big time and away from income. As you show in the chart the median income has stayed roughly the same, but peoples’ property taxes have gone up astronomically. Healthcare has gone up like crazy too. Income taxes (brackets only matter insofar as the rate they are being charged).

    And, I do expect the Roth to be taxed — I just don’t trust them to keep their word — sorry, I’m a pessimist. I would definitely prefer the tax break today to the one promised tomorrow.

  31. Don’t forget about inheritances… the power of a ROTH IRA in that situation is a huge advantage. You can set up you heirs with tax free income for generations to come.

  32. mimi: IMHO, Today’s contributions to a Roth will always be tax free. 20 years from now they might get rid of Roth’s all together but they wouldn’t tax existing Roth’s.

  33. I think the goverment likes the idea of the Roth because they can get the tax revenue today. Future budget problems and the prospect of taxing the already taxed accounts will be someone else’s problem long after they’re gone. They just want to be sure to get their funds today so they can build another bridge to nowhere.

  34. MikeS, I agree with Paul 100%. I don’t understand what you mean when you say “we have to remember that your upfront tax rate for retirement savings is usually budgeted at the margin, but I think it should really be budgeted at the effective rate paid”.

    If you are in the 25% tax bracket and decide to contribute to your Roth 401(k), you pay 25% income tax on that contribution, not the lower effective rate. Of course, you pay zero tax upon withdrawal. However, if you contribute to your 401(k), you pay zero income tax today, and pay the effective rate in the future. So, unless you expect your effective rate in the future to be higher than your marginal rate today, why contribute to your Roth 401(k)?

  35. CodingSlave says

    While the problem sounds incredibly complicated, it doesn’t have to be a this or that solution. Remember that the maximum you can contribute to a Roth is 5k give or take. And most people are probably saving more that that for their retirement. I for one am planning to save 10k annualy and put 5k in roth and 5k in 401k. Hedge your tax bets and put as much as you can qualify for in Roth and the rest in 401k. That way, if taxes go up, your roth is better off and if taxes go down, 401k is better off.
    I mean we’ve all decided that we can’t predict the markets and hedge our bets in index funds, mutual funds etc. So why can’t we acknowledge that we can’t predict if the taxes will go up or down and hedge our bets in both Roth and 401k?

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