Roth vs Traditional IRA: Which One Is Better?
Ever since the Roth IRA became an option in 1997 with the passing of the Tax Relief Act, the question has been asked, which is better...a Roth IRA or a Traditional IRA?
The Traditional IRA
The traditional IRA is named the traditional IRA because it was around before the Roth IRA...therefore making it "more" traditional. The traditional IRA allows the individual to contribute money before tax is taken out or deducted from income. Therefore, it is easier to contribute more money to a Traditional IRA. As time passes, money inside a traditional IRA grows tax deferred. However, this means that when the individual reaches retirement and begins to take money out of the IRA, they will pay taxes at their ordinary income tax rate as money is removed from the IRA to use in retirement.
The Roth IRA
The Roth IRA was named after its main legislative sponsor, Senator William Roth of Delaware. As a person contributes money to a Roth IRA, it will be contributed after tax has already been deducted from income. Growth inside of a Roth IRA grows tax free and when the person reaches retirement, the money can be removed from the Roth IRA tax free.
So Which One Is Better?
The question of which one is better depends on a couple different factors. First, do you believe that tax rates will be higher in the future than they are now? If you do, it may be better to choose a Roth and pay tax today rather than waiting to pay tax tomorrow(in retirement). If you don't, then maybe the opposite is true.
Second, how much money do you make today and do you project yourself to be wealthy in the future? This is a difficult thing to project as no one knows what the future may hold. But it's important for a couple reasons. First, if you make a lot of money today, you may not be eligible to contribute to a Roth IRA. There are certain income limits that prohibit high income individuals from contributing to a Roth. Second, if you project yourself to be wealthy in retirement, then you will likely be in a higher marginal tax bracket in retirement years and thus it may be wise to pay tax today as long as paying tax today doesn't jump you into "today's" next tax bracket.
Does Trump's Tax Plan Affect Either One?
No, based upon our limited research, it does not appear that Trump's tax reform plan will have a direct affect on your decision to choose a Roth IRA or a Traditional IRA. However, it may impact your projection of future tax rates as either lower or higher than they are today, thereby potentially impacting your decision between a Roth IRA or Traditional IRA.
Roth Vs Traditional IRA Calculation
The calculation for determining which IRA is better really centers around tax rates now versus tax rates in the future. Our Roth versus Traditional IRA calculator allows a person to do this calculation very quickly and easily, however, there will always be an unknown variable and that is your future tax bracket. The best a person can do is estimate what their future tax bracket will be and plug and play with the calculator to see its effect on your IRA choice.
Like many things in the retirement game, there are unknowns, and this is no different when choosing a Roth IRA or a Traditional IRA. If future tax rates remain the same, then it doesn't matter which one you choose to participate in...however, like most things in the retirement game, it's likely best for a person to be diversified between investment vehicles. So a person should likely consider using both a Roth IRA and a Traditional IRA to fund their retirement. It may be best to consult with your financial advisor on the matter as well.
IQ Calculators hopes you found this article helpful and be sure to leave a comment in the comment section.