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Traditional IRA vs. Roth IRA: What’s Your Preference?

Written by Nickel - 25 Comments

I recently wrote about the advantages of tax-deferred (traditional) vs. Roth retirement contributions. That post sparked an interesting discussion about the value of Roth vs. traditional accounts in the long run.

Each approach has its advantages, and the optimal strategy may vary based on your circumstances. For example, if you’re currently in a low tax bracket, Roth contributions may be in your best interest. On the other hand, if you’re currently in a higher tax bracket, you might be more interested in an upfront tax deduction.

Given the importance of this topic for retirement planning, I thought that it would be worth running a poll to facilitate further discussion. When answering the question below, assume that you have both options at your disposal.

If given the choice, would you prefer to take the upfront tax break of tax-deferred contributions, or the back-end tax break associated with investing in a Roth account?
Total Votes: 360 Started: May 21, 2010 Back to Vote Screen

As always, I encourage you to not only participate in the poll, but to also weigh in with a comment providing some context for your answer.

Published on May 21st, 2010
Modified on August 28th, 2011 - 25 Comments
Filed under: Polls, Retirement, Saving & Investing

About the author: is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!

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25 Responses to “Traditional IRA vs. Roth IRA: What’s Your Preference?”

  1. 1
    savvy Says:

    If you’re in a higher tax bracket, you won’t get a deduction for traditional IRA contributions. Therefore, a Roth is the better option.

    If you’re in a low tax bracket and can spare the funds, it’s probably better to forego the traditional and pay the taxes now vs having to pay a higher tax rate at withdrawal.

  2. 2
    Nickel Says:

    savvy: Don’t forget that your first $18,700 (currently; for married couples filing jointly) in income is tax free due to the standard deduction and your personal exemptions. That makes having at least a bit of traditional money *very* valuable. You can draw out the tax free portion (maybe even fill up the lowest brackets) before touching the Roth money.

  3. 3
    Floridian Says:

    We’ve got both – for the exact reason Nickel mentions – you CAN have some “taxable income” on which you pay no income taxes thanks to exemptions and standard deduction.

    The ROTH vs Traditional decision will vary not only based on current and expected tax brackets, but also time. Time is a huge factor for us – we have 20+ years until we retire – that’s a LONG time for money to grow completely tax free in a ROTH – so everything over what is required for the minimum employer match for the tax deferred (“traditional”) account is going to the ROTH right now. I fully expect that as we get older (and into a higher tax bracket and/or lose certain deductions), we will switch those ROTH contributions to Traditional contributions. I’m sure there will be a time in our lives again when the up-front tax benefit will be more beneficial to us, but that time is not now.

  4. 4
    Dan Says:

    Floridian, I think you misunderstand something here. All things being equal, it makes no difference whether or not you choose a Roth or Traditional.

    Say you have $6000, you want to invest it for 30 years, and assume an 8% return. You’re in the 25% tax bracket now, and expect to be taxed at 25% when you withdraw.
    The math for traditional is: Balance = PreTaxPrincipal*((1+ReturnRate)^GrowthYears)*(1-TaxRate).
    The math for the Roth is: Balance = PreTaxPrincipal*(1-TaxRate)*((1+ReturnRate)^GrowthYears).
    Get this: Because multiplication is communicative, it makes absolutely no difference if you pay the tax before the compounding (Roth) or after (traditional).

  5. 5
    missjulied Says:

    If I had the choice, I’d take the upfront tax break. I expect us to be in a much lower tax bracket when we retire.

    As it is now, I don’t have a choice as we’re priced out of a Roth anyway.

  6. 6
    Dan Says:

    Nickel, this is my favorite PF subject these days. (Hey, it’s a bit more interesting than “pay off your debts, don’t borrow money for consumption purposes, and create a budget.”)

    One of the things that bugs me with some of these PF topics, is that just about everybody talks about generalities. For instance, when we talk about debt interest rates, the advice is “If you have high interest rate debt, pay it off before you save for retirement.” But what’s a high interest rate? Nobody ever addresses that.

    Same here. The advice is “if you are in a low income tax bracket, use your Roth.” Well, what’s low? IMHO, anybody who is in the 25% marginal bracket is nuts for investing in a Roth at the expense of having no taxable income whatsoever in retirement (ie traditional accounts.)

    You pointed out that the first $18,700 for MFJ is tax free — and it should be noted that these values are indexed for inflation. If you’re in the 25% marginal bracket now, for the “Roth Only” choice to be mathematically correct, the income tax rates for these inflation-adjusted brackets would have to be greater than 25%. They’re currently, 0%, 10%, and 15%! Even if they go up a lot, the odds that the tax paid on income in these brackets average out to 25% are quite slim!

    For the Roth-only to be correct, we wouldn’t be looking at “tax increases,” we’d be looking at major tax policy changes. I’m just not confident congress can get its act together and agree on something like that.

    Now, if one is in what is currently the 15% bracket, it is less likely that he errs when investing in the Roth at the expense of no taxable income.

  7. 7
    Anthony Says:

    The difference for me is when I retire. With a Roth IRA, I will not be taxed at retirement. With a traditional, I will be. Yeah, I can take a tax deduction now with a traditional. But if I can afford it, then I don’t care!

    Suppose I take the traditional IRA route, contribute money every month/year, earn some assumed rate of return, and end up with $2 million.

    On the other hand, if I take the Roth IRA route, I make the same contributions, earn the same theoretical rate, and still end up with $2 million.

    With the traditional IRA, I WILL be taxed. With the Roth, I won’t be.

  8. 8
    Floridian Says:

    Thanks Dan – but I definitely don’t misunderstand when it comes to retirement & tax planning. I’m a CPA with advanced degrees in both Finance and Accounting. I won’t get sucked in to another argument of which is better on a stupid message board, b/c no one can tell anyone which is the better way to go without knowing the full financial story of their life. I know full well the tax implications of each and have made the better decision for US. For OUR situation (considering all things including tax brackets, available deductions & credits now and in the future, time, and the magic of compound interest) ROTH contributions make much better sense for us THIS year…and probably will for the next few years or so – at least until we lose certain other credits/deductions and/or hit the 25% tax bracket…and that likely won’t happen unless my husband goes back to work (he’s a SAHD).

    :)

  9. 9
    Chris Says:

    We can only speculate what the tax situation will be in the future. It wouldn’t surprise me to see our debt-heavy government start creative ways to regain ROTH IRA “losses” . Through a VAT, for example.

    Accepting that I don’t know the future I diversify between the two. Obviously, if you are at a stage where your tax bracket is relatively low compared to the long term, fill the ROTH first.

  10. 10
    John Says:

    so far i have not invested in Roth, although I am at the very top end of the 15% bracket. Lat year I took home all I could without paying any tax at 25%. This year I will attempt to do the same again, but I will have some cash on hand at the end of the year to make a lump-sum contribution. If I need more deductions to get back to the 15% tax rate, I will invest in traditional IRA up to that point. After that point is reached I will invest the remainder of my available cash in a Roth IRA.

    My goal is to effectively max out the 15% tax bracket every year with take-home income, debt repayment, and Roth contributions. When I get my consumer debt eliminated, then I can max out my Roth annual contribution.

    This brings up another question. What is the priority between debt repayment and Roth contributions. In both cases you are using taxed dollars. To me this depends on the expected returns of your Roth, the cost of maintaining the debt, and the Roth contribution limit. If you need a good credit score for buying a home or car then you might want to knock out some debt instead of investing in a Roth to improve your credit score. If you have very good terms on the debt and don’t need more credit, then you might push more into the Roth if the investing climate is favorable.

    Roth IRAs have the benefit of being penalty free on withdrawals within limits. If a debt goes bad or you need money unexpectedly, you can pull that money back out and use it. With a 401(k) or a traditional IRA you will pay penalties for withdrawal before age 59.5.

  11. 11
    Dan Says:

    Anthony,

    There’s two flaws in your logic:

    1. Contributing $5k to a traditional/401k isn’t the same as contributing $5k to a Roth. If you’re in the 25% bracket, you actually had to earn $6,666.66 to make those contributions to the Roth. If you contributed the same $6,666.66 to a 401k, you’d have the exact same amount in the end. With the 401k, you’re investing the full $6,666.66! With a Roth, you’re only contributing $5k. If the tax rates are the same, it really doesn’t matter if you pay them now (Roth) or pay them later (Traditional.)

    2. Even with taxable income (traditional account) you probably won’t pay any taxes at all on some of it. That’s because of the way the tax brackets work. Did you realize that this year, the first $18,700 a married couple earns is not taxed at all? Presuming these exemptions exist in the future (and I have no reason to think they won’t) I’d rather have some income on which the tax rate is nothing than pay 25% taxes up front on that same income.

  12. 12
    Dan Says:

    Floridian –

    I just have one advanced degree in math :P (And this is all high school algebra anyway ;) ) My tax life is pretty simple — MFJ, no kids. I could file the EZ form if it wasn’t for the student loan interest deduction…

    I’m far from a tax expert, but I suppose it doesn’t take much to imagine a scenario where an MFJ with two kids has no tax liability whatsoever? (In which case, the Roth is a no brainer.)

  13. 13
    Funny about Money Says:

    This tax stuff is so complicated that no one can understand it without a CPA certification and advanced degrees in accountancy or math.

    Do I have it right in thinking that it’s to your advantage to be able to use your money tax-free in retirement, when your income drops and you need all you can get your hands on to cover your living expenses? For me, trying to live on a third of what I earned before being laid off, having to pay taxes on Social Security and drawdowns from savings is quite onerous–one of several circumstances that combine to make life difficult.

    And do I understand correctly that a Roth IRA can be passed to your heirs with no strings attached, whereas with a traditional IRA, they’re going to lose a chunk of it when you die?

  14. 14
    Aaron Says:

    The one thing I’m considering is since I’m trying to pay down debts, wouldn’t it be better despite the lower tax rate I am in now than likely later to go Traditional 401K/IRA for the tax credit, since that would leave me with more money to pay down my debts faster?

  15. 15
    Daron Says:

    I’m in the 28% bracket and have abandoned the Roth 401 in favor of the traditional since I firmly believe I will be making significantly less in retirement than I make now. In essence, if I work long enough to amass enough to maintain my income I will have wasted my life to some degree, so I’ll quit working as soon as I can.

    The logic is simple…I make a bunch less in retirement, say $40,000 before whatever Social Security provides, so my average tax rate is around 11% or so, with the marginal at 15%. Way less than 28% today. So it’s a fairly easy call right now.

    What if tax rates change, which is likely? I don’t think it will much matter as long as my retirement income is so low. so the decision of Roth v traditional stays the same.

    As an additional consideration, I have some Roth that will be used for the one-time expenses in retirement like cars, house repairs and upgrades, and several major vacations. I am planning to lump those withdrawals as much as possible in the same year to manipulate the tax situation just like I do today with my property taxes, charitable contributions (prepay one year, post pay one year, etc), and interest (I actually don’t have any of that, but still).

    It may look sort of complicated, but it’s really not. It’s just my reaction to my best guesses for the distant (40 years) future.

  16. 16
    Meg Says:

    On factor that no one has mentioned (I don’t think) is that Roths have different implications for retirement withdrawals and estate planning. You don’t have to take required minimum distributions with a Roth, which can be hugely beneficial if you plan to pass that money on to others or if you don’t need all those funds to live off.

    But also, I know what Floridian means with regard to the time till retirement being a factor. I’m in my 20’s and am putting over $20K into Roth retirement accounts this year (401k plus IRA). Mathmatically it may look the same to pay taxes now vs later, but in reality paying $5K (25%) on Roth contributions now is a lot different than paying $250K on $1M of Traditional withdrawals (also 25%)!

    To make the Traditional calculation come out the same you have to assume the tax savings are invested – and never touched, and compounded at the same rate of return as the Roth contributions – every year through retirement. Realistically that never happens.

  17. 17
    BG Says:

    Dan #4) Your wrong, sorry.

    With a traditional account, some of your money is tax-free NOW and IN RETIREMENT. With Roth, you are always paying a tax.

    Let’s assume I contribute $18,700 this year, and retire next year (and withdraw all that money next year — no growth assumed).

    If I put the $18,700 into traditional accounts (IRA or 401k): I need to earn $18,700 this year and contribute that full amount. Next year, I withdraw all $18,700. End result: $0 in taxes paid (due to standard deduction and personal exemptions for MFJ).

    If I go with Roth (assume 25% bracket): I earn $18,700 — pay $4,675 in taxes, and invest the difference: $14,025. Next year I withdraw the $14,025 tax free (it’s tax free because it’s a Roth, but also because your allowed $18,700 in standard deductions and personal exemption). End result: $4,675 paid in taxes.

    Traditional: $0 in taxes
    Roth: $4,675 in taxes

    I pick traditional — don’t know about you…

  18. 18
    Aaron Says:

    BG,

    You’re wrong, too, if you’re gonna look at it that way.

    Let’s say on the flip side you’re making $25,000/yr right now, making your income tax level effectively 0%. You put $5,000 in a Roth IRA. You therefore pay $0 in taxes on the 5K you put into that Roth IRA, as you would with a Traditional IRA regardless of how much you make right now assuming you’re eligible.

    If 40 years from now, let’s say you’re withdrawing today’s inflation adjusted level of $100,000/yr., had you put the money in a Roth IRA, you won’t get taxed on the withdrawals. Had you chosen the traditional IRA, you WILL pay taxes.

    You can’t cherry pick a perfect situation for a traditional IRA and claim that’s always right.

    I’m sorry, but it’s really simple, choose a Roth IRA if you think your marginal tax rate is lower now than in retirement, and choose a traditional IRA if you think your marginal tax rate now will be higher than it will be in the future. Personally, I’m hedging my bets, utilizing a Traditional 401k and a Roth IRA.

  19. 19
    BG Says:

    #18 Aaron) I was disputing Dan’s comment in #4:

    “..All things being equal, it makes no difference whether or not you choose a Roth or Traditional…”

    You disputed his statement too. There is no way to have ‘all things being equal’, specifically because of the tax bracket structure we have. If we had a flat-tax with no exemptions, then I’d agree with Dan — but we don’t have that system.

    In a flat-tax system, the first dollar is taxed at the exact same rate as the last dollar. But, our system has the first $18,700 (MFJ) not taxed at all, and the last dollar taxed higher (25% for me) — which changes the equation completely.

  20. 20
    Aaron Says:

    Well, he said all things being equal. That would include your tax bracket.

  21. 21
    Steve Says:

    Arguments why you should invest ALL your retirement money in a Roth account.
    1) You can afford the taxes now but won’t be able to afford them later.
    FALSE. Dan’s comment #4 applies here – if you put the money in a tax-deferred account, you can use the extra money in the account to pay for the taxes.

    2) You expect tax rates to rise.
    FALSE. Unless you expect a fundamental change to our progressive tax system, some amount of money will always be taxed at a very low rate.

    3) You expect your personal marginal tax bracket to be higher in retirement.
    FALSE. This is not a reason to invest ALL your money in a Roth account. Not all of your withdrawals in retirement would be taxed at your marginal rate.

    4) You are a long way from retirement
    FALSE. Dan’s comment #4 applies here as well. It doesn’t matter how much the account rises, because it’s a percentage of what’s in the account. So due to the commutativity of multiplication it’s a wash.

    5) You expect a paradigm shift in tax policy (e.g. switch from a progressive income tax to a national VAT)

    MAYBE. Depending on what you expect, and whether or not you expect a special exemption for Roth assets. (or rather, what the conditional probability of the two events is.)

    6) If you amass $2 million in the account, it will be worth more if it’s tax-free.

    FALSE (more or less.) It is easier to get $2 million in a traditional account than a Roth account. It is in fact, 25% easier if you are in the 25% tax bracket. Again this argument is a wash.

    If you are using this to trick yourself into saving more effective dollars, then this might be true.

    7) You plan to leave a lot of the money to your heirs.

    TRUE. You won’t be required to make RMD’s.

    8 ) You might need the money before retirement and/or might retire early.

    TRUE. You can withdraw the contributions at any time at least.

    This can can be helpful e.g. if you are forced to choose between putting money in a Roth and in an emergency fund. If you put it in the emergency fund and don’t fully fund your Roth in a given year, and don’t end up needing the money, you have lost out on the Roth contributions forever. If you put it in a Roth (invested in a cash equivalent) and have to withdraw it, you are no worse off than you would have been otherwise.

    There is a lot of misinformation in this thread.

  22. 22
    BG Says:

    #20 Aaron) Even if you assume the tax brackets are equal today and retirement, you are still better off putting more (if not 100%) into the traditional account than in the Roth.

    This is a fact. If you put 100% of you money into a Roth, you are throwing away your _future_ personal exemptions and standard deductions you qualify for in retirement.

    Specifically on that $18,700 (MFJ) invested into the Roth, you are paying $4,675 in taxes today for no reason at all (unless you like to donate money to the government). If you put enough into traditional to cover the 0% bracket ($18,700 MFJ) you’ll have in retirement: you pay $0 taxes today, and $0 taxes in retirement on that money.

    With a Roth, you are always paying taxes — and at the highest current tax rate.

    With a Traditional, you can avoid all taxes today and also most taxes in retirement, on at least a portion of that money.

    There is no “wash”.

  23. 23
    Aaron Says:

    BG,

    You’re assuming there is no variation on the tax rate paid on the money put into a retirement account today. There simply is variation in that depending on your current income, deductions you can make, etc. You’re also assuming too rigidly there won’t be other taxable income in retirement. That creates a perfect storm scenario for the Traditional IRA accounts.

    You cannot assume that you ALWAYS are paying taxes on a Roth guaranteed. With the $18,700, you’re again assuming you know it’s $4,675 in taxes paid today for everybody when it’s not. In the extreme case, if you make $18,700/yr today, and somehow could put any money in an IRA, Roth is a no brainer. Even if you were to only withdraw enough to fill the 0% tax bracket upon retirement, at worst in a Roth in that case, you broke even. Why mess with a sure thing in that scenario and put it in a Traditional IRA? That’s an extreme example, but it proves the point that Traditional IRA’s are not always a better choice.

    My personal strategy is mix the two to provide pots of money I can strategically draw from when I retire. I can withdraw some from each, filling in lower tax brackets with money from Traditional IRAs, then withdraw from the Roth to make up the rest. My feeling is right now, most of my money should be going to Roth for a few reasons:

    A. I’m nowhere near a higher tax bracket (or even anything high).
    B. I’m early on in my house mortgage, so interest is the overwhelming majority of my mortgage payment.
    C. I have exceptionally high deductions from other things like a student loan, my current employer offers a very high FSA top limit I can take advantage of, I’m about to do some energy efficiency upgrades to my house that qualify for deductions, etc. It’s a safe assumption these will go down in the future.
    D. I’m relatively early on in my career, so my income should be climbing if anything.
    E. I’m a student of history enough to know taxes will have to go up long term.

    All of these point to now being a better time to fill up that Roth bucket than later. All of the above point to me paying higher taxes as time goes on, so I’ll switch more to Traditional later to make up for what I’m doing now.

  24. 24
    BG Says:

    #23 Aaron) sounds like you have a plan. I’m all for going with a large Roth contribution, but for certain years only. But, in the end, the majority of your contributions should have been into a traditional account.

    A good example when you should invest in Roth (for a single year):

    You are in the 28% tax bracket, and get laid off. You have a cushy savings, so you make large Roth contributions in the year you are not working (because you have an abnormally LOW marginal tax-rate for that one year only). In the previous year you were in the 28% bracket, current year you wind up in the 15% bracket, and next year you’ll be back in the 28% bracket. In that case you should be doing: Traditional in the first year, Roth in the year you had an abnormally low marginal tax rate, and back to traditional when your income picks back up the following year.

    As for the 112 people in the poll (so far) that have chosen Roth-Only — wrong, wrong wrong!

  25. 25
    Peter Says:

    Some spirited discussion above, and very divergent views!! The analytically inclined ones rightly point out the wash (when all else is equal, which is practically never), and the dependence on your current marginal tax rate versus that at the time of withdrawal. Elsewhere, I’ve seen the argument called “tax diversification” – which means amassing a retirement portfolio with a good balance of pre-tax and post- or non-taxable assets. Then, at withdrawal you can really play the game of maxing out your income within a specific bracket. For myself, I’ve been shut out of Roth accounts for most of my working years, hence portfolio wasn’t balanced from a “tax diversification” point of view. Recently made some corrections to this through Roth conversion (opened to me in 2010) and going forward through Roth 401K, available to me starting in 2012. Even though my current bracket is high (35%) I intend to go Roth for a couple of years (I’m already 53), and then continue with Traditional until I retire in 10 to 15 years. This doesn’t necessarily make sense if you look at it narrowly as the strategy that will generate the best after-tax income during retirement. But when you factor in the biggest unknown – how many years one may live in retirement, you necessarily must plan for a reserve or surplus. If you die early – the assets pass to those you choose. For those assets passing through to your beneficiaries, the Roth type is much better than Traditional.

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