HUNT VALLEY, Md. (TheStreet) -- You've probably heard or read something similar to this next statement regarding Traditional IRAs and Roth IRAs:
"If you expect to be in a higher tax bracket in retirement than you are today, contribute to a Roth IRA. If, instead, you are likely to be in a lower tax bracket in retirement, contribute to a traditional IRA."
Which is better -- a dollar in a Roth IRA or a dollar in a traditional IRA The answer's not as simple as some would have you believe.
By this logic alone, if your tax bracket would never change, there's virtually no difference between the two. But, like many personal finance one-liners and rules of thumb, this one falls woefully short of giving you the whole story.
Which is better -- a dollar in a Roth IRA or a dollar in a traditional IRA? As long as you're expected to pay taxes
This is where the TurboTax prompter would say, "Most people will fall into this category"
the answer to this question is always the dollar in the Roth. One hundred percent of the time. This is because the Roth allows you (and your heirs) tax-free growth
distributions free from taxation. The dollar in the traditional IRA, on the other hand, is subject to taxation whenever you (or your heirs) remove it. The higher your tax bracket, the less your traditional IRA dollar is worth.
If you're in a 25% tax bracket, your traditional IRA dollar is actually worth only 75 cents.
So what's all that stuff about the traditional being better if you're in a higher tax bracket today than you expect to be in retirement? For that logic to work, we must assume you take the extra cash on hand, born from your tax deduction specifically associated with your T-IRA contribution, and invest it for your retirement. If you make a $5,000 contribution to a traditional IRA and you're in a 25% tax bracket, your deduction should be worth $1,250; for the traditional to benefit you more than a Roth, you must not only to be in a lower tax bracket in retirement, you also have to save that additional $1,250 for retirement.
But what do most people do with their tax refund?
What if you use your refund as a down payment on a car or for a vacation? The traditional edge is eliminated. What if you didn't get a refund at all? Unless you write a check to invest the amount you should have gotten as a deduction for your T-IRA contribution after you write Uncle Sam a check, the Roth wins.
One of the great frustrations in financial planning is that most of the planning is based on assumptions of things we can't actually control or change -- annual income, inflation, market returns and, of course, taxes. So you can contribute to a traditional IRA
By the way, if your company offers a retirement plan (such as a 401k) and you make more than $66,000 (last year or this year) as a single or $110,00 as a couple, married and filing jointly, you can't deduct your contribution anyway!
, calculate the proportionate amount of tax deduction and invest it
Of course, if you've maxed out your IRA contribution, you also have to invest the tax deduction proceeds somewhere else -- likely in an account requiring you to pay taxes on interest, dividends and capital gains as they're realized
-- every year -- and hope $14 trillion U.S. deficits and a wave of increased entitlement spending somehow doesn't lead to tax increases.
Or you can take control of one of those factors and prepay your taxes using a Roth IRA
It's quite possible that the most attractive features of a Roth don't have anything to do with taxes. Unlike a traditional IRA or a 401(k), a Roth allows you to take back your contributions at any time, at any age, for any reason, without paying taxes or penalties. Furthermore, you're not required to take Required Minimum Distributions from Roth IRAs -- ever. So unlike a traditional IRA, which forces you to accept fully taxable income after you reach the age of 70.5, your money continues to grow in a Roth unimpeded.
It would be a mistake to assume my resolute opinion on the benefit of Roth IRA contributions over those in traditional IRAs also applies to Roth IRA conversions. That's an entirely different story... with thoughts to come.
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Timothy Maurer, CFP, is vice president of
, based in Hunt Valley, Md., and a member of NAPFA, the National Association of Personal Financial Advisors. He can also be found at
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.