Roth vs traditional IRA
October 3, 2019 6:52 PM Subscribe
Today I saw a financial consultant (a free one, provided by Major Institutional Retirement Plan). I told him that I make $15K more per year than I'll need (or likely have) to live on in retirement, and he went on to advise me to put the extra in a Roth IRA. I was like, wait, why would I do that? And got a handwavy answer. But I'm right, right? In my situation I want a traditional IRA?
If you have a sufficiently high income (not that high, if you have $15K hanging out after expenses you are probably above it) and your work offers Major Retirement Plan, you may not be eligible to make traditional deductible IRA contributions. It's still better to take advantage of a tax-advantaged retirement account than not. But you still can't put $15K in a Roth in any given year!
posted by praemunire at 7:15 PM on October 3, 2019 [1 favorite]
posted by praemunire at 7:15 PM on October 3, 2019 [1 favorite]
Some advisors recommend a Roth IRA because your tax break is shifted to retirement so you won't be able to spend it like you might with the present-day tax breaks of a traditional IRA.
posted by bluecore at 7:20 PM on October 3, 2019 [1 favorite]
posted by bluecore at 7:20 PM on October 3, 2019 [1 favorite]
The Roth IRA gives you tax advantages on the back end. If you feel like down the road you'll be in a higher tax bracket than today, you should opt for a Roth.
The traditional IRA gives you a tax break today. You'll get taxed on it when you pull money from it later as income. This is better for people currently in a high tax bracket, but won't be during retirement.
posted by lownote at 7:40 PM on October 3, 2019 [2 favorites]
The traditional IRA gives you a tax break today. You'll get taxed on it when you pull money from it later as income. This is better for people currently in a high tax bracket, but won't be during retirement.
posted by lownote at 7:40 PM on October 3, 2019 [2 favorites]
Response by poster: To clarify, he didn't mean the whole $15K. Is there any scenario in which a person making more now than they will in retirement would want to use a Roth rather than a traditional IRA?
posted by HotToddy at 8:06 PM on October 3, 2019
posted by HotToddy at 8:06 PM on October 3, 2019
The difference between a Roth IRA and a regular IRA, with both following the same investment strategy, is generally hundreds of dollars over the course of decades worth of investing, so I wouldn't lose any sleep over it.
The answer really comes down to do you need the money now (as in the minor tax break that a traditional IRA offers) or are you good with getting it in the future? Do you think there will be changes that will impact your taxable social security (or medicare eligibilty) or other income?
posted by The_Vegetables at 8:17 PM on October 3, 2019
The answer really comes down to do you need the money now (as in the minor tax break that a traditional IRA offers) or are you good with getting it in the future? Do you think there will be changes that will impact your taxable social security (or medicare eligibilty) or other income?
posted by The_Vegetables at 8:17 PM on October 3, 2019
Best answer: Is there any scenario in which a person making more now than they will in retirement would want to use a Roth rather than a traditional IRA?
Yes, here’s a few:
1) You don’t want to take required minimum distributions in retirement
2) You want to pay taxes now to take advantage of the current tax breaks
3) You want to avoid the uncertainty of tax rate hikes in the future
4) You don’t have the discipline to invest the tax savings from your traditional IRA deductions (which you need to do to make the 2 types comparable)
5) You might need the money before retirement, or you want to retire early (you can withdraw Roth contributions without penalty)
posted by doctord at 8:42 PM on October 3, 2019 [17 favorites]
Yes, here’s a few:
1) You don’t want to take required minimum distributions in retirement
2) You want to pay taxes now to take advantage of the current tax breaks
3) You want to avoid the uncertainty of tax rate hikes in the future
4) You don’t have the discipline to invest the tax savings from your traditional IRA deductions (which you need to do to make the 2 types comparable)
5) You might need the money before retirement, or you want to retire early (you can withdraw Roth contributions without penalty)
posted by doctord at 8:42 PM on October 3, 2019 [17 favorites]
Best answer: One reason to invest in a Roth IRA is that nobody knows where the tax brackets will be (or what the tax system will look like!) on timescales of decades. Traditional IRA's make sense if your marginal tax rate in retirement is lower than it is today. Most of us assume that will be true based on our expectations about our income and expenses later in life. But that neglects the fact that future governments might change the tax rate! If it goes up significantly, you'll be glad you put it in a Roth IRA.
A common strategy faced with this uncertainty is to hedge your bets, i.e. put some fraction of your retirement savings in a traditional tax-deferred account (often a majority, in the form of a maxed out traditional 401k), and some fraction in a Roth IRA (e.g. a maxed out Roth IRA). If you're also making significant 401k contributions, your advisor's advice is pretty reasonable!
Another reason to go for a Roth is if you're above the income threshold to deduct contributions to a trad IRA. In this situation, a trad IRA has neglible advantages. You're also over the income limit for a Roth IRA. But you can still make Roth IRA contributions via a "Backdoor Roth".
posted by caek at 9:34 PM on October 3, 2019 [6 favorites]
A common strategy faced with this uncertainty is to hedge your bets, i.e. put some fraction of your retirement savings in a traditional tax-deferred account (often a majority, in the form of a maxed out traditional 401k), and some fraction in a Roth IRA (e.g. a maxed out Roth IRA). If you're also making significant 401k contributions, your advisor's advice is pretty reasonable!
Another reason to go for a Roth is if you're above the income threshold to deduct contributions to a trad IRA. In this situation, a trad IRA has neglible advantages. You're also over the income limit for a Roth IRA. But you can still make Roth IRA contributions via a "Backdoor Roth".
posted by caek at 9:34 PM on October 3, 2019 [6 favorites]
Best answer: Doctord has it exactly right. Two more considerations: it's possible you are in the range of income where you make too much to contribute to a traditional IRA but little enough that you still qualify for a roth IRA. And, you did use the word "likely," but just because you make 15k less than you need right now doesn't mean that your income will be 15k less in retirement.
There's the relatively simply math of figuring out the likelihood of being in a higher or lower tax bracket (NOTE: tax bracket, not income level) in retirement. But if you aren't sure, the ROTH offers more advantages than traditional: no RMDs, ability to withdraw contributions, and ability to contribute at higher incomes. That said, lots of smart people think that if you have the means you should hedge your bets - since none of us know for sure what tax brackets will be in the future nor exactly what our income level will be, it makes sense to, for example, contribute to a traditional 401k and a ROTH IRA.
posted by exutima at 9:35 PM on October 3, 2019 [5 favorites]
There's the relatively simply math of figuring out the likelihood of being in a higher or lower tax bracket (NOTE: tax bracket, not income level) in retirement. But if you aren't sure, the ROTH offers more advantages than traditional: no RMDs, ability to withdraw contributions, and ability to contribute at higher incomes. That said, lots of smart people think that if you have the means you should hedge your bets - since none of us know for sure what tax brackets will be in the future nor exactly what our income level will be, it makes sense to, for example, contribute to a traditional 401k and a ROTH IRA.
posted by exutima at 9:35 PM on October 3, 2019 [5 favorites]
Best answer: I agree with Veggie. I did the analysis a few years ago and came to the same conclusion, for the person who is considering using her own earned money. A traditional IRA or a 401-k is funded with before-tax dollars, but the pro for the quid is that it is taxed (as ordinary income) when distributed. A Roth is funded with money on which you have already paid the tax, and any later distribution is tax-free, including the earnings. At least for now.
The analysis is far different for someone who receives additional money, say an inheritance, which comes to her tax-free to begin with. Then a Roth is a very useful idea as way to provide for tax-free growth and tax-free distributions later, when needed or desired, and tax-free distributions to heirs after she is gone.
Someone who is interested in a little creativity could, within a Roth, put some money into ten new companies with growth potential. If one or two really take off, then the situation at the end of a few decades is far different. If I had done that 20 years ago, with Apple or Amazon as one of the investments, perhaps I would not be writing this now.
Assuming that you are relatively young but with no dependents, the very first thing that I would think of is disability insurance. If there are dependents, make that #2, with life insurance as #1.
posted by megatherium at 5:04 AM on October 4, 2019 [1 favorite]
The analysis is far different for someone who receives additional money, say an inheritance, which comes to her tax-free to begin with. Then a Roth is a very useful idea as way to provide for tax-free growth and tax-free distributions later, when needed or desired, and tax-free distributions to heirs after she is gone.
Someone who is interested in a little creativity could, within a Roth, put some money into ten new companies with growth potential. If one or two really take off, then the situation at the end of a few decades is far different. If I had done that 20 years ago, with Apple or Amazon as one of the investments, perhaps I would not be writing this now.
Assuming that you are relatively young but with no dependents, the very first thing that I would think of is disability insurance. If there are dependents, make that #2, with life insurance as #1.
posted by megatherium at 5:04 AM on October 4, 2019 [1 favorite]
To my thinking, the big advantage of a traditional IRA compared to a Roth IRA is that you might be able to save more towards retirement due to the front-loaded tax savings. However, since you expect to have more than you need to fund the maximum of either type of account, that doesn't really apply to you. The advantages of a Roth are numerous as outlined above. My general approach, which may not be appropriate for you, would be to fund any 401ks up to the employer match, then fully fund a Roth IRA up to its maximum, then fund the rest of your 401K up to its maximum, then invest for medium/long term needs. This assumes you already have an emergency fund. The Roth can kind of serve as an emergency fund in it pinch since you can withdraw contributions penalty free, but it's best not to have to do that since you only have so many opportunities to get money into the account.
posted by willnot at 4:41 PM on October 4, 2019 [1 favorite]
posted by willnot at 4:41 PM on October 4, 2019 [1 favorite]
This thread is closed to new comments.
But also yes, if you have $15K spare each year you’re likely not in a tax bracket where a Roth is going to be a useful tool.
posted by amelioration at 7:12 PM on October 3, 2019 [2 favorites]