Traditional vs. Roth – Which One is Better?

In my lasts two posts, we talked about two different types of accounts that can be used to save for retirement and build wealth: IRAs and 401(k)s

As you may recall, there were variations of each of these accounts, defined as Traditional and Roth.

We’re going to do a deep dive on the difference between Traditional and Roth accounts so you can decide which one is best for you.


Ultimately, we want to answer the question: Between a Traditional and a Roth account, which option is better for you?

Photo by Jon Tyson on Unsplash

To provide that answer, we are primarily going to focus on taxes

Bleh, I know. Taxes. Gross. Did you just lose interest? No worries. I did too. But try to think of it not as boring politics and accounting, and instead think about how saving on taxes will enable you to build more wealth.


How Traditional and Roth Accounts are Taxed Differently

The primary difference between a Traditional IRA and a Roth IRA is how they are taxed. Check out the table below.

TraditionalRoth
ContributionsPre-taxPost-tax
DistributionsTaxed as incomeTax free

For a Traditional IRA, contributions (money you put in) are made pre-tax. In other words, you don’t have to pay taxes on money that you put in a Traditional IRA. That’s pretty cool! 

Here’s an example: If your annual income is $50,000 per year and you contribute $5,000 to a Traditional IRA, then the $5,000 is not included in your taxable income. Instead, your taxable income would be $45,000, and you pay less in taxes as a result.

While your contributions are tax-free with a Traditional IRA, distributions (money you take out) are taxed as regular income. 

Basically, with a Traditional IRA, you avoid taxes now, but pay taxes later.

A Roth IRA is the opposite. You pay taxes now, but avoid taxes later. You contribute after-tax income to a Roth IRA, but you do not have to pay any income taxes when you take a distribution.


Other Considerations

The primary differences of a Traditional IRA versus a Roth IRA are how they are taxed, but there are a few other considerations as well.

  • You can withdraw your contributions from a Roth IRA at any time without penalty.
    • All withdrawals from a Traditional IRA before 59.5 years old are subject to ordinary income taxes plus a 10% penalty.
    • If you withdraw any investment gains (earnings) from a Roth IRA prior to 59.5, these are also subject to ordinary income taxes plus a 10% penalty. You can only withdraw contributions prematurely.
  • A Traditional IRA has Required Minimum Distributions; after age 72 you must start withdrawing from Traditional IRA. 
    • This requirement does not apply to Roth IRAs.
  • Roth IRAs are not available to high-income earners. 
    • The benefits of a Roth IRA begin phasing out at $125,000 and $198,000 of adjusted gross income for single and married filers, respectively. 

Which One Should I Choose?

The answer is always: it depends

But first, I want to point out some “propaganda” that you may have encountered when it comes to Traditional versus Roth IRAs. 

You might have heard before that you end up with more money in a Roth because of “tax-free growth”. It is true that the growth of your investments in a Roth IRA are tax-free, but that doesn’t necessarily mean you’ll end up with a higher balance. Remember to always check the numbers.

For example…

  • If you were going to take $100 out of your paycheck to contribute to a Roth IRA, the $100 would be taxed first. If you were in the 22% tax bracket, then you would pay $22 in taxes and $78 would go into your Roth IRA.
    • After 30 years, at 6% growth, this would amount to $76,012.01.
  • If, instead, you contributed $100 to a Traditional IRA, then you wouldn’t pay any taxes, so the entire $100 goes into your Traditional IRA.
    • After 30 years, at 6% growth, this would amount to $97,451.30.

Wait, so Traditional is actually better then?

Well, with a Traditional IRA, you still have to pay taxes eventually. You instead pay the taxes you skipped when you take a distribution. If you withdrew $97,451.30, and you were taxed at 22%, you would be left with…

You guessed it! $76,012.01

The government is gonna get your money one way or the other.

The point here is that, mathematically, things work out the same. Decide what works best for you

Here are 6 questions to ask yourself to determine which is the best option for you.

  1. Will you need any of the money before you are 59.5?
    • If so, a Roth IRA would be a better option because you can withdraw your contributions before 59.5 without taxes or a penalty. Of course, it’s rarely recommended to take early withdrawals so your money can grow as much as possible, but you have the flexibility with a Roth IRA.
  2. Would you be tempted to make an early withdrawal?
    • This is where it’s important to understand your own financial behavior. If the growing balance starts calling out to you to buy a boat instead of continuing to save, maybe the 10% penalty that applies to the whole balance of a Traditional IRA would help you stick to your goals.
  3. Do you want to leave some (or all) of this money to your family, or even a charity?
    • If so, a Roth IRA would be a better option because a Traditional IRA requires minimum distributions at age 72.
  4. What is your annual income?
    • The benefits of a Roth IRA begin phasing out at $125,000 and $198,000 of adjusted gross income for single and married owners, respectively. A Traditional IRA would be your only option if your income is high enough, but there are worse problems to have 🙂
  5. Do you expect to have higher or lower income when you begin taking distributions from your IRA?
    • If you will be at a higher income when you start taking distributions, then a Roth is a better option because you will avoid the taxes that will then be applied at a higher rate. 
    • A Traditional IRA would be better if you are a high-income earner now, but plan to have a leaner retirement.
  6. What kind of saver are you?
    • The example I gave above that showed how you end up with the same amount of money in a Traditional or a Roth has a caveat. That example looks at taking $100 out of your take-home pay. 
      • For a Traditional IRA, the contribution is the entire $100. 
      • For a Roth IRA, some taxes are paid out of this $100 first. 
    • If you contributed a full $100 to a Roth IRA, and paid the taxes with other money or part of your income, you would end up with that higher balance ($97,451.30) AND not have to pay taxes on your distributions.
    • This may be a bit confusing, so I’ll lay it out like this.
      • If you prefer the simpler approach of just making a budget from your take-home pay, then a Roth IRA is possibly a better option. Just decide on the $X you want to contribute. You will have more money in the long run, and are unlikely to notice the taxes that came out of your paycheck by the time it was direct deposited into your account. Most people don’t track every penny of their gross income so may find the Roth to be the option that gives them more money in the long run.

The same rules generally apply to Roth versus Traditional 401(k) accounts. They have the same differences when it comes to taxes. One caveat is that a Roth 401(k) does not allow for early withdrawals of your contributions, like a Roth IRA does. 

What other questions do you have when it comes to deciding between a Traditional or Roth IRA? Let me know in the comments!

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