By Kaye A. Thomas
Current as of February 6, 2018
A Roth account is effectively bigger than a comparable traditional account. For most people, this is the main reason to choose a Roth.
Why choose a Roth IRA or a Roth account in your employer’s 401k or 403b plan when you can get a deduction for contributions to a traditional account? The simplest reason is that the tax rules allow you to build a Roth account just as large as a traditional account, and when you retire, the Roth account will be more valuable.
Same total account size
The contribution limits for Roth accounts are the same as for traditional accounts. You also have the same investment opportunities for both types of accounts. That means you can build a Roth account to the same size as a traditional account.
The Roth account is more valuable
Nevertheless, the Roth account is more valuable. Distributions from a traditional account are taxable, while distributions from the Roth account are not. The difference can be surprisingly large. For example, if you’re in the 22% tax bracket, you have to withdraw $128.21 from a traditional account to have $100 in spending power, because $28.21 will be used to pay tax on the distribution. Here’s a chart showing the amount you would need in a traditional account to have the equivalent of $100 in a Roth account, for each of the current tax brackets.
Saving in a Roth account can make you as much as 58% wealthier in retirement! When you take state income taxes into account, the difference can be even greater.
Paying tax in retirement
Unless you’re close to retirement and have a good handle on what your income and deductions will be, it’s hard to even guess what your tax bracket will be. If you’re guessing it will be on the low side, be sure you aren’t overlooking the following:
- More and more people work at least part time during “retirement,” either to help make ends meet or simply to keep active.
- Up to 85% of your social security benefits can be taxable.
- With a sound investment approach, your retirement account should grow substantially over the years, and that will mean large withdrawals when you begin taking the money out. If the money is in a traditional account, these withdrawals will boost your income and possibly put you in a higher tax bracket than you might otherwise expect.
- Various budget realities, including huge costs associated with the aging and retirement of the baby boom generation, make it difficult for the federal government to achieve lasting reductions in tax rates.
So traditional accounts always lose?
This doesn’t mean the Roth account is always better. Choosing the Roth means paying more tax in the year of the contribution, because a Roth contribution doesn’t reduce your taxable income. If the tax difference ends up as a difference in the total amount you save, it’s possible for the traditional account to come out ahead.
Example: You’re prepared to contribute $4,000 to a traditional IRA, but if you switch to the Roth you’ll cut back to $3,040 because you’re losing the tax deduction.
In this situation we can’t be sure which account will end up providing more wealth in retirement. Your Roth IRA starts out 24% smaller than the traditional IRA, and that means the traditional IRA can end up being more valuable if your tax rate in retirement is below 24%. Yet the Roth IRA has other advantages that can make it come out ahead, as discussed in other pages of this guide.
Here’s the bottom line. To come out ahead with a traditional IRA, you have to contribute more money than you would have contributed to a Roth IRA. Even then, there’s a good chance the Roth will provide you with more wealth in the long run.