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Traditional vs. Roth IRA

| May 10, 2017

One of the many questions we get as advisors is “what’s better; a traditional or Roth IRA?” The answer is: they both have their benefits.

Let’s first analyze how they both work and if you qualify.

Note that the annual contribution limit for both a Roth and Traditional IRA is $5,500 if you're under 50 years of age and $6,500 if you're 50 or older.

A Traditional IRA grows tax deferred, the “up front” benefit is that any contributions you make are tax deductible. You will end up paying ordinary income tax once you start to make withdrawals from a Traditional IRA, and you are required to start making withdrawals, known as RMD (required minimum distribution) at age 70 and ½. You can estimate what your RMD may be by using the calculator on our website here. Also, if your employer offers a 401k at work, you cannot make contributions to a Traditional IRA.

View it from this perspective, Uncle Sam gave you all those tax breaks up front, so they can get their piece of the pie at the end. That pie will be much bigger when Uncle Sam is getting his piece because of all the compound interest that’s helped your IRA grow over the many years you have been making contributions. If you’ve contributed $1,200 a year for 30 years, and your IRA grew at a hypothetical 8%, you would have an IRA value of $146,815 and you would have only contributed $36,000. If you are in the 30% tax bracket you would be getting a deduction so your $1,200 annual contribution would only “feel” like a $840 dollar contribution.

A Roth IRA does not have an “up front” benefit. Meaning you do not get a tax deduction for your contributions. However, your Roth IRA grows tax free. If we take the same contribution example as above, you would not end up paying any taxes on withdrawals of your $146,815, and there are no RMD requirements for a Roth IRA. However, there is no deduction for your contribution, so your $1,200 contribution “feels” like $1,200.

The great benefits of a Roth is that it eliminates a risk, your tax risk. To determine tax risk, ask this question: “What will taxes be when I retire?” Unfortunately there is no way to predict what the tax rates will be when you withdraw the balance, or what tax bracket you will be in at that time. Tax law is continually changing and we have no way of knowing what taxes will be next year, let alone in 30 years.  

Note that if your employer does offer a 401k at work, you can still make contributions to a Roth IRA. However, if you’re income is between $118,000-$133,000 and you’re single, or $186,000-196,000 if you’re married, you can only make partial contributions to a Roth IRA, you can determine those partial contributions using a calculator on our site here. If your income is above those amounts you cannot contribute to a Roth IRA.

When attempting to answer the question of which is a better fit for you, keep the factor of time in mind. If you’re many years away from retirement you have a much longer period of compound growth, you get a much greater benefit on the back end with a Roth. If you’re closer to retirement, and won’t get as great of a benefit from the compound growth from a Roth, so it might make sense to have a traditional to get the tax deduction.

I’m not advising anyone reading this to make the decision based on the above literature. I’m simply pointing out some of the benefits of both IRAs. I am advising you to speak with a professional advisor before you make the decision, as they will be able to take your personal situation into account and advise which is more suitable.

If you would like to contact one of our advisors, or contact us for a consultation you can do so here. We are always happy to help and answer any questions if we can.