#RothVsTraditional: Understanding the Key Differences
What is a Roth IRA?
A Roth IRA is a retirement account where you contribute after-tax dollars, and your investments grow tax-free. This means that when you withdraw money in retirement, it is not taxed.
What is a Traditional IRA?
On the other hand, a Traditional IRA allows you to contribute pre-tax dollars, meaning you get a tax deduction now. However, when you withdraw money in retirement, it is taxed as ordinary income.
Benefits of a Roth IRA
– Tax-free withdrawals in retirement
– No required minimum distributions (RMDs)
– Ability to pass on tax-free assets to heirs
Benefits of a Traditional IRA
– Tax deduction on contributions
– Lower tax bracket in retirement
Roth vs Traditional: Which is Better?
The decision between a Roth and Traditional IRA depends on your individual financial situation. Here are some factors to consider:
– Current tax bracket
– Expected tax bracket in retirement
– Timing of withdrawals
– Estate planning goals
Why Have Taxable Income in Retirement?
Having taxable income in retirement can be beneficial for several reasons:
– Qualifying for certain tax credits and deductions
– Ability to take advantage of tax-efficient investment strategies
– Diversification of tax treatment on retirement savings
In conclusion, while having tax-free income in retirement sounds appealing, it’s important to consider the benefits of having a mix of Roth and Traditional retirement accounts. Consulting with a financial advisor can help you make the best decision based on your individual needs and goals.
Sometimes you make enough money during working years where it makes financial sense to do tax deferred all the way and reduce current taxes.
That does not automatically mean you pay higher taxes later. In fact you can strategically convert this money to Roth later on at a super low bracket over a number of years if you play it smart.
The standard deduction is $29,200 for a married couple filing jointly. If you make below that you pay no income taxes, including in retirement.
Assuming $2,000/mo -> $24,000/yr total SS payout for a couple, the first $5,200 in 401k or IRA withdrawals are not taxed at all. This is a double tax free situation that is very desirable. It takes $130,000 in tax-deferred accounts to reliably generate $5,200/yr per the 4% rule. So if you’re not on track to at least that amount in tax deferred accounts at retirement, then contribute to tax-deferred accounts.
However, if your tax bracket in retire is higher than your current one (i.e. you expect to be rich in retirement), you may want to do Roth contributions, which are taxed upfront but not at the end.
you arent factoring what taxes you need to pay to be able to contribute to a Roth account today. take a generalized example:
I earn $10k of income that I want to invest, I am squarely in the 24% tax bracket, and I have access to the same investments in each account. I have 3 options:
Option A – I put $10k into my traditional 401k. Over the next X years that money triples and I have $30k. When I withdraw this money in retirement, I fill my tax brackets from the bottom up.
Option B – I put ($10k x 76% = $7.6k) into my Roth 401k. Over the next X years that money triples and I have $22.8k. When I withdraw this money in retirement, I pay no further taxes.
Option C – I put ($10k x 76% = $7.6k) into my taxable brokerage account. Over the next X years that money triples and I have $22.8k, minus any tax drag from dividends, capital gains distributions, and/or rebalancing. When I withdraw that money, I pay capital gains taxes.
so in those three scenarios, its easy to see that Option B is strictly better than Option C. so the question then is if Option A or Option B is better. its pretty clear to see that as long as my effective tax rate on my withdrawals is less than 24%, then Option A is better than Option B. Given that for most people in retirement, they draw less income than they earned while working, combined with the fact that we have a progressive tax structure, where you fill the lower brackets first and work your way up, odds are very likely that your effective tax rate in retirement will be less than your marginal tax rate during your working years, outside of cases where you have a large taxable income in retirement (ala a large rental real estate portfolio or large pension).
Roth is always best in your retirement years. However doing pretax contributions means you likely pay less taxes on your money in retirement than you do on that money during your working years. By paying no taxes on that money during your working years, it creates more taxable income. Then you take that money out and pay less effective tax than you would have.
So in a vacuum no you don’t need or want to have taxable income. But having taxable income in retirement means you avoided taxes during your working years.
Why pay %24 on your income now if you can defer it to the future and lay 10% on it later?
Dollar for dollar you’d rather that your entire net worth be in Roth at the time of your retirement.
The problem is that getting dollars into pretax accounts is considerably easier due to not being taxed at earn time.
So your best total financial outcome is often to put all or most of your money into pretax accounts despite the impaired nature of the asset on the back end. Because the sheer amount of dollars you are able to save that way (and under certain scenarios the inaccessibility of Roth accounts) is the best bang for your buck.
I certain can’t explain it. It seems so simple unless you do the math especially with your 2.8 million. I’m RMD from my traditional.
My social security when added to almost any other income becomes taxable to some degree. I know it’s popular to say social security won’t be there but during the 80’s, when I was in my 40’s, social security was running out of money. That was partially fixed or delayed by taxing it. The more taxable income you have in retirement the more they take back. ($7K this year for me.)
[My largest source of income is RMD from my traditional IRA.](https://imgur.com/a/ek3bx8n) This is my fourth year of RMD and at the end of 2024 will have been forced to withdraw and pay tax on $424,792. The “extra” I don’t need goes into my taxable brokerage account. In fact yearly more money is flowing into the account than during any 5 year period while I was working (probably more like 10 year period).
So, in addition to tax on RMD there will forever be increasing tax drag on my taxable accounts.
[I won’t even mention the $4K Medicare bonus premium I’ve been paying since I started Medicare.](https://imgur.com/SKHqQNE) That certainly doesn’t count towards the traditional penalty, does it?
My average 401(k) contributions over 19 years, including employer match which was untaxed compensation, was less than than current IRA contribution limits.
Of course, if I was withdrawing from [Roth](https://imgur.com/a/IpSE6Xa) I’d only pay $28.5K less federal tax.
I’ll admit there’s things I don’t understand like filling marginal tax brackets from the bottom. I never once received a pay check with $0 withheld because early in the year the dollars I was paid was below standard deduction. I was always withheld based on my yearly income broken into number of pay periods (Pub 15-T). So I paid tax and saved tax on the traditional contributions from payday one. I do the yearly income/tax estimate so I can withhold from my withdrawals (using 15-T as a cross check.)
I’ll add that when I officially retired at 66 and started withdrawing from the IRA I had about 1.7 million. After 9 years of withdrawals I’m in the 2.8 category. 700K in withdrawals and the balance refuses to go down.
I think you are way ahead.