Roth or Traditional IRA? A Roth is Almost Always the Right Answer
NEW YORK (MainStreet) Some investors agonize over every decision, even to the point of gridlock. One of the most often asked questions in matters of personal finance is, "Should I have a Roth or Traditional IRA?" Most advisors will say the choice boils down to predicting your future income tax rate. Think it will be higher? Get a Roth. Expect to be in a lower tax bracket in retirement? Contribute to a Traditional IRA. And while that binary test still prevails, for most investors the answer may be even simpler.
"While the benefits of Roth IRAs are more pronounced for Millennials, our research shows the majority of investors would still be better off using a Roth IRA than a Traditional IRA," says T. Rowe Price senior financial planner Stuart Ritter.
Ritter conducted a study to determine how investors in different age groups benefit from the tax advantages of Roth IRAs. The research compared retirement income generated by Roth IRA compared to that of an investor who used a Traditional IRA.
The study assumes an investor retires at age 65 and contributes $1,000 into a Roth IRA or a Traditional IRA at various ages. Being in a 25% tax bracket at the time of their contribution, the $250 tax deduction from the Traditional IRA would be invested in a separate taxable account. An annualized 7% return is assumed for all investment accounts during the accumulation phase, but drops to 6% for all three accounts during a 30-year retirement.The results revealed that a 25-year-old who used a Roth IRA and remains in the same tax bracket in retirement would have nearly 20% more spendable income in retirement than an investor who selected a Traditional IRA instead. But Ritter says the Roth tax advantage goes beyond benefiting only young adults. "Since most investors remain in the same tax bracket in retirement, the Roth IRA can generate more spendable income even for an investor who made their contribution at age 65," he says. In fact, the Roth IRA produced more spendable retirement income in most of the scenarios analyzed -- except for investors nearing retirement who see their income tax rate fall. "A significant drop in tax rates between when the investor made her IRA contribution and began retirement withdrawals can often be offset by the power of tax-free compounding," Ritter says. "But for investors nearing retirement, there isn't enough time for the money to compound at a rate to counter the significant reduction in their tax bracket during retirement." If an investor is over 50 years old and his taxable income falls by at least 9%, the Traditional IRA becomes more valuable, according to Ritter's study. A 65-year old would need only a 6% drop in his tax bracket for a Traditional IRA contribution to be more advantageous than the Roth IRA in retirement. --Written by Hal M. Bundrick for MainStreet
Check Out Our Best Services for Investors
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
- Model portfolio
- Stocks trading below $10
- Intraday trade alerts