Roth vs. Traditional IRA

It seems many financial advisers today have a strong opinion about which type of IRA is the better way to invest for retirement.  I’m not a financial expert, but I cringe when I hear somebody emphatically state that one type or the other is clearly superior, when it really is not that simple.  The correct answer depends on several factors, and I think so-called “experts” are doing a disservice when they try to steer a financial novice like me in one direction or the other without a proper explanation.  Please note that I don’t have any fancy initials after my name, so I’m not to be relied on for sound financial advice.  This post reflects my limited (and possibly out-of-date) understanding of the subject.

Traditional IRAs, along with other “deferred compensation” plans, let you invest the money before taxes.  The money can then grow tax free until retirement, at which time you withdraw it (usually over the course of years), and pay any income taxes applicable.

Roth IRAs, on the other hand, require that you pay taxes on the money before you invest it, so you don’t get any immediate tax benefit.  However, that means that you don’t have to pay tax on it, nor the gains, when you cash it in at retirement.  In addition, you have fewer restrictions since you’ve already given Uncle Sam his share.  In many cases you are allowed to withdraw the amount you invested (but not the gains) even before retirement .  You are also not required to withdraw certain amounts per year during retirement as you are with a “deferred compensation” plan.

So which one is better?  Unless you can predict the future, the answer isn’t clear.  It depends in part on whether your tax rate during retirement is higher or lower than it is now. If your tax rate during retirement is the same or higher than now, it can make the Roth more attractive.  If your tax rate will be lower in retirement, then a traditional IRA or deferred comp plan looks better.  The adviser I heard speak today on this issue seemed to say that since 90% of people are in a lower tax bracket during retirement, a traditional IRA or deferred comp plan is the better choice.  However, it is not clear at all to me that I’ll be in that 90%.

In 2009, the 25% tax bracket extends from about $33,000 to $80,000.  I currently fall into that tax bracket. While I don’t intend to retire rich, the current projections by my financial planner put me in the same tax bracket at retirement.  Because of that, a Roth IRA may well be a better deal for me.  Of course, it depends on what our unpredictable government decides to do as well.  Obama expressed support during his campaign for removing all income taxes, even the filing requirement, for those retirees making less that $50,000.  If that would come to pass, I would most certainly be a lower tax bracket (0%) at retirement, and therefore I’d be better served with using a traditional IRA or deferred comp plan for my investing.

However, with the ballooning national debt and shortfalls in Medicare and Social Security, it seems to me that the government will start to expect more of retirees, not less, and the tax rates may very well increase.  If that happens, a Roth will be the far better choice for me. Perhaps putting some money toward each plan is a good strategy, so you don’t lose too much regardless of what Uncle Sam does.

In summary, my answer as to which investment type is better is simply: I don’t know!  But in my opinion, that’s a more accurate answer than the one I heard today from the financial adviser.

Here are some useful links:

Traditional vs Roth IRAs, according to

A calculator to help you decide