Roth Vs. Traditional - What Should I Use??

Well, happy Friday! It's time for another Finance Friday. Today we're going to be talking about the difference between a Roth and a Traditional IRA or 401(k), and which one you might want to be using for retirement savings. So, here we go.


So, to start simply on this question, because there is a lot of subtle nuance to it, I just want to start by saying the main difference is the tax bracket you're in when you are paying the income tax.


So, with a Roth IRA or a Roth 401(k), you're choosing to pay the taxes today. And with a traditional, you're choosing to pay the taxes at some point in the future. So, the general thought, or the quick answer to the question is, well, do you expect to be in a higher tax bracket today or in the future? Because you want to pay the taxes when you're in the lower tax bracket.


So, if you're in a low tax bracket today, maybe you're young, fresh out of college, new job, and you're building up your income, then it's probably a good idea to pay that today. So, you'd choose that Roth option. If you're at a high-income stage in your life and you're maybe in that top tax bracket, you might want to defer that into retirement where potentially you'll be in a lower income tax bracket.


So, that's the first point I would say is, it's mostly a question about the tax bracket that you're in when you choose to pay the income tax.


So the second piece that I would say is, the dollars aren't the same. If you can save $6,000 into a Roth IRA and $6,000 into a Traditional IRA, that's not the same amount. $6,000 in a Roth is more valuable than $6,000 in a Traditional IRA. That's not a recommendation for one over the other. I just want you to understand, if all you're going to do is put $6,000 in your mind into one of them, the $6,000 in the Roth is already after tax and it has more after-tax value to you.


A more fair comparison is $6,000 into a Roth vs. $6,000 into a Traditional, and then whatever that contribution to the Traditional IRA saved you in taxes, you need to take that amount, too and invest it in a taxable account. Now, that taxable account will grow slightly slower than a Roth would, but it's just something to think about. Six thousand into each is not exactly an apples to apples comparison.


The third thing that I would say is, there might be a planning reason why you would choose one or the other.


With assets in a Roth, you don't have to deal with required minimum distributions when you turn, I guess now it's 73 or 75 depending on the year you were born. You don't have to deal with required minimum distributions later in life. So that can be a benefit. Some people really don't like those required minimum distributions. So that's something to think about.


Also for passing assets to future generations, a Roth can sometimes be a more friendly vehicle to choose to do that with. With an IRA, they have to pay the income tax when they take the money out. (With a Traditional IRA) The beneficiaries have to pay the income tax to get the money out, whereas with a Roth, it's all tax free. It's a nice benefit in terms of passing wealth to future generations.


So, that's the three things I would say. It's a tax bracket question. The dollars are not the same in the two accounts. And then the third one is there might be a planning reason outside of that tax consideration where you might opt for one over the other.


It can be complicated. It can (and should) certainly be based on your own individual situation. You can talk to a financial planner to help you understand your tax brackets across time because it can be tricky. You make money, it grows over time. You retire, your income goes down. Social security kicks in, your income comes up a bit. Required minimum distributions come in, income comes up a little bit more.


So your tax bracket or your effective tax rate over time can change. And so the answer to the question of "What should I be contributing to, a Roth or a Traditional account?" can change over time.


Have a great Friday. Feel free to reach out if you have any questions and we'll talk to you soon. Thanks.