IRA: ROTH VS TRADITIONAL

​Roth IRA versus traditional IRA: which is better for you?
 
Roth IRAs tend to get a lot of hype, and for good reason: Because you pay the taxes upfront, your eventual withdrawals (assuming you meet the age and holding-period requirements—more on these below) are completely tax-free.
 
While we like “tax-free” as much as the next person, there are more times than you would imagine when a traditional IRA will put more money in your pocket than a Roth would.
 

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​Making the Decision on What’s Best
 
Example. Say that your tax rate is 32 percent and that you will invest $5,500 a year in an IRA and earn 6 percent interest. Should you put the $5,500 a year into a Roth or a traditional IRA?
 
Say further that neither you nor your spouse is covered by a workplace retirement plan, so you can contribute the $5,500 a year without worry because it’s under the contribution limits.
 
Traditional IRA
 
If you invest the $5,500 in a traditional IRA, you create a side fund of $1,760 ($5,500 x 32 percent).
 
On the side fund, you pay taxes each year at 32 percent, making your side fund grow.
 
Roth IRA
 
Roth contributions are not deductible; this means no side fund, so your annual investment remains at $5,500.
 
Cashing Out
 
For the Roth, your marginal tax rate at the time of your payout doesn’t matter because you paid your taxes before the money went into the account. The whole amount is now yours, with no additional taxes due.
 
But for the traditional IRA, your current tax bracket matters a great deal. You have taken care of the taxes on the side fund annually along the way, but the traditional IRA (both growth and contributions) is taxed at your current marginal tax rate at the time you cash out.
 

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​The table below shows you how this looks with tax rates 

Marginal Tax Rate at ​Cash- Out	10 years @ 6%	20 years @ 6%	30 years @ 6% ​	40 years @ 6%
22%	Trad: $74,557 Roth: $69,858	Trad: $202,074 Roth: $194,964	Trad: $421,482 Roth: $419,008	Trad: $801,048 Roth: $820,238
​32%	Trad: $67,571 Roth: $69,858	Trad: $182,578 Roth: $194,964	Trad: $379,581 Roth: $419,008	Trad: $719,024 Roth: $820,238
37%	Trad: $64,079 Roth: $69,858	Trad: $172,830 Roth: $194,964 ​	Trad: $358,630 Roth: $419,008	Trad: $678,012 Roth: $820,238

You can see that the traditional IRA needs a low tax rate at the time of cash-out to win. But even in the 22 percent cash-out tax rate, the Roth wins at the 40-year mark.

​Rate of Growth
 
What about your rate of growth? Do variances here change things any? Let’s take a look.
 
Here, we’ll look at different rates of growth for a fixed period (30 years) before you withdraw your money. Once again, we’ll consider three different marginal tax rates at the time you cash out—22 percent, 32 percent, and 37 percent.

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Marginal tax rate at cash-out	3% for 30 years	6% for 30 years	9% for 30 years	12% for 30 years
22%	22% Trad: $257,760 Roth: $245,013	Trad: $421,482 Roth: $419,008	Trad: $716,547 Roth: $742,876	Trad: $1,256,032 Roth: $1,351,463
32%	Trad: $233,259 Roth: $245,013	Trad: $379,581 Roth: $419,008	Trad: $642,260 Roth: $742,876	Trad: $1,120,886 Roth: $1,351,463
37%	Trad: $221,008 Roth: $245,013	Trad: $358,630 Roth: $419,008	Trad: $605,116 Roth: $742,876	Trad: $1,053,312 Roth: $1,351,463

​

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In the scenarios above, the traditional IRA/side fund combo wins only when your marginal tax rate is lower at the time of withdrawal and only at the lower growth rates.
 
At higher rates of return—9 percent and 12 percent, in our examples above—the Roth still wins, even if you’re in a higher tax bracket when you withdraw your money.
 
Tax Factor
 
What’s going on here?
 
For starters, the side fund is not tax-favored in any way.
 
Plus, taxes hobble your cash-out on the traditional IRA:
 

• You pay taxes as you earn the money in the side fund.
• You pay taxes on the accumulated growth inside the traditional IRA when you withdraw the money.

 
If you would like to discuss how the Roth or traditional IRA can fit into your retirement plans, please contact us.

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