Ques. on regular v. Roth IRA

[psychopengy]

I have a question on the merits of a regular vs. a Roth IRA. I currently have about $31K in a Roth IRA and about $25K in a regular IRA. If I make a $5,000 contribution (I'm eligible for make-up contributions) to my Roth IRA as opposed to my regular IRA, I'll pay approximately (correct me if I'm wrong) $750 in taxes at the 15% marginal tax rate (which I'm at). I'm aware that my withdrawals from the Roth IRA won't be taxed. However, if I had instead made the $5,000 contribution to my regular IRA , I could have had that $750 in some after-tax investment compounding for years. Even though my regular IRA withdrawals will be taxed at my prevailing tax rate (let's assume 15% again), it just seems that I'll come out better with a regular IRA. Is my thinking right on this?
A little more information about myself: I'm 50 years old, no dependents, I have a low income (about 25K/yr.) and don't expect to be in a higher tax bracket later on.

[Ima saver]

Re: Ques. on regular v. Roth IRA

I personally prefer the roth ira. Who knows your situation when you retire? I would rather not have to pay taxes on the ira money when I retire.

[disneysteve]

Re: Ques. on regular v. Roth IRA

One difference to keep in mind: traditional IRAs require you to start taking distributions by 70-1/2. ROTHs do not, so if you don't need the money yet, you can leave it there growing tax-free until you do.

[poundwise]

Re: Ques. on regular v. Roth IRA


This is another one of those 'which is best' question that doesn't have an absolute answer.


I think the bottom-line factors for consideration are:

Contributions
Roth - Not deductible
Traditional- Deductible

Earnings
Roth - Tax free
Traditional - Tax deferred

Qualified Withdrawals
Roth - After age 59.5 and/or amount up to contribution may be withdrawn early, no age at which you must begin taking withdrawals
Traditional - After 59.5, at age 70.5 you must begin taking withdrawals

Withdrawals
Roth - Tax free
Traditional - Taxed as income


The main argument, as I understand it, for the traditional IRA over the ROTH is that since your investment is tax deductible for the tax year contributed, you get more value for your investment dollar. In other words, if you contribute $2000 into your traditional IRA, you would need personal earnings of $2000 gross to do so. Whereas, in order to contribute $2000 into a ROTH, you would need $2500 gross earnings (assuming a 20% tax bracket for this example.)

The argument for the ROTH is that your contributions grow tax free rather than tax deferred. That is, when you begin to make withdrawals from your traditional IRA, you will pay tax on that money as income. Whereas, with the ROTH, the account was funded with money that was already taxed, therefore you do not pay tax when making your withdrawals in retirement.

Why do some favor the traditional IRA? The tax savings now may enable you to put more into your IRA. The more that you can contribute, especially early, the more compounding works in your favor over time. Some also add that one may expect to be in a lower tax bracket when retired than now, and therefore paying taxes later, rather than the tax year when contributed, makes sense as well.

Why do some favor the ROTH? Tax free sounds a lot a better than tax deferred. When you are able to make qualified withdrawals, you do not pay tax. Also, the ROTH offers greater flexibility for early withdrawal. Not that you would want to, but in certain scenarios being able to access funds prior to age 59.5 may be favorable. The ROTH allows you to withdraw contributions (not earnings) prior to 'retirement' age without penalty. Early withdrawal from the traditional IRA comes with a double-whammy of taxes and 10% penalty.


My personal conclusion is that I prefer the ROTH. Let me clarify. As long as you can fund the IRA to the extent that you want to, or to the maximum allowed, I favor the ROTH. If you are going to struggle to or be hindered in contributing as you wish/need, then the fact that the traditional IRA comes with what amounts to tax savings now, may help you contribute more for your retirement.

The argument that the traditional is better because contributions are tax deductible and therefore you can put more in for less 'cost' to you becomes mute if and when you fully fund a ROTH IRA. You can't invest more than 'fully funded' no matter what. So, if you can put the max in, I think the ROTH is a no-brainer. Otherwise, there has to be some consideration of the initial savings offered by the traditional IRA, as it will 'add up' over time as you invest and your investment grows.

That's my take anyway. By the way, I am not a financial professional. This is my layman's understanding and opinion. I recognize that there are other factors and rules, however, I believe my statements are accurate and are the factors that matter for virtually everyone, whether they come to the same conclusion that I have, or not.

[sweeps]

Re: Ques. on regular v. Roth IRA

poundwise and disneysteve make some good points. All things being equal, it makes no difference whether you go the traditional route or the Roth route. You end up with the same result when it's time to withdraw.

Of course, rarely will things ever be equal. You have to consider what your income is like now and at retirement, the state of the tax laws now and at retirement, your eligibility for tax breaks now and at retirement, when you need to withdraw (to disneysteve's point), can you afford the max post-tax contribution (to poundwise's point), and other considerations.

One thing that I think is misleading is calling traditional IRA's tax-deferred and Roth IRA's tax-free. That makes it sound like you're never taxed when you choose the Roth route, but of course you are. It's really more of a tax-me-now or tax-me-later debate.

[Ima saver]

Re: Ques. on regular v. Roth IRA

Excellent answers!!

[disneysteve]

Re: Ques. on regular v. Roth IRA

One thing that I think is misleading is calling traditional IRA's tax-deferred and Roth IRA's tax-free. That makes it sound like you're never taxed when you choose the Roth route, but of course you are.

I see your point. Just to clarify for those who may not fully understand the difference, the money that you invest in a Roth grows tax-free and you owe no taxes on qualified withdrawals. But the money that you put in has already been taxed. With a traditional IRA, you get a deduction for contributing. Then the money grows tax-free. But when you start withdrawing it in retirement, since you didn't pay taxes on it up front, you need to pay taxes on it at that point.

If you Google "IRA calculator" you'll find a variety of online resources for running the numbers and comparing the two choices.

[WellManicuredMan]

Re: Ques. on regular v. Roth IRA

I agree with poundwise. If you can max out your Roth or your Traditional IRA without any problems, then of course the Roth is the best way to go. Roth you pay taxes on your contribution. Traditional you pay taxes on your contributions AND your earnings (when you take it out). I'd rather only pay taxes on part of the money (Roth), not all of it (Traditional).

And the fact that you can take out your contributions at any time penalty and tax free from a Roth makes it an even better deal (for emergency situations).

[poundwise]

Re: Ques. on regular v. Roth IRA

One thing that I think is misleading is calling traditional IRA's tax-deferred and Roth IRA's tax-free. That makes it sound like you're never taxed when you choose the Roth route, but of course you are. It's really more of a tax-me-now or tax-me-later debate.

Sweeps, this is absolutely correct. This is why I specified that the earnings are tax free and the withdrawals are tax free (not subject to income tax.) It is not that the ROTH IRA itself is tax free. The contributions (investment) are taxed.

[poundwise]

Re: Ques. on regular v. Roth IRA

I agree with poundwise. If you can max out your Roth or your Traditional IRA without any problems, then of course the Roth is the best way to go. Roth you pay taxes on your contribution. Traditional you pay taxes on your contributions AND your earnings (when you take it out). I'd rather only pay taxes on part of the money (Roth), not all of it (Traditional).

And the fact that you can take out your contributions at any time penalty and tax free from a Roth makes it an even better deal (for emergency situations).

Thanks for agreeing with me! But, it is not correct to say that with a traditional IRA you 'pay taxes' on the contribution and the earnings.

On a traditional IRA, the contributions are tax deductible (you don't 'pay taxes' on that income.) With a ROTH, they are not. Neither are taxed while the account earns. When it is time for withdrawal, the ROTH is not taxed, but the traditional is. This is where Sweep's phrase, 'tax me now or tax me later' applies.


Here is a good, simple summary:

http://www.fool.com/ira/ira03.htm

[WellManicuredMan]

Re: Ques. on regular v. Roth IRA

Thanks for agreeing with me! But, it is not correct to say that with a traditional IRA you 'pay taxes' on the contribution and the earnings.

On a traditional IRA, the contributions are tax deductible (you don't 'pay taxes' on that income.) With a ROTH, they are not. Neither are taxed while the account earns. When it is time for withdrawal, the ROTH is not taxed, but the traditional is. This is where Sweep's phrase, 'tax me now or tax me later' applies.

Maybe I'm confusing a Traditional with a 401(k)... I thought they were basically the same. So with a Traditional you don't pay the taxes now, but you do have to pay them later because you owe tax on the entire balance when you retire, right? I take that to mean that you pay tax on the contributions and the earnings, which isn't as good as only paying tax on the contributions as with a Roth.

[jmjj215]

Re: Ques. on regular v. Roth IRA

The OP's original presumption is a bit off IMHO which is where some of the confusion came from (I think).

If you have $5,000 to invest in a Roth before tax then you really only have $4,250 to invest after-tax in your Roth. So you would invest $4,250.

If you were investing $5,000 into your Roth and paying the $750 in taxes, then you'd technically have $5,750 truly available, and that could be invested in your Traditional IRA.

In the end, it all comes down to what your tax rate is now vs. what it will be then. If your MTR is only 15% right now man, for sure I'd go for the Roth. Don't you want your MTR to be really really high during Retirement? That means you'll be making lots of money

[WellManicuredMan]

Re: Ques. on regular v. Roth IRA

The OP's original presumption is a bit off IMHO which is where some of the confusion came from (I think).

If you have $5,000 to invest in a Roth before tax then you really only have $4,250 to invest after-tax in your Roth. So you would invest $4,250.

If you were investing $5,000 into your Roth and paying the $750 in taxes, then you'd technically have $5,750 truly available, and that could be invested in your Traditional IRA.

In the end, it all comes down to what your tax rate is now vs. what it will be then. If your MTR is only 15% right now man, for sure I'd go for the Roth. Don't you want your MTR to be really really high during Retirement? That means you'll be making lots of money

And taxes are probably going to be higher in the future due to the huge deficit.

But going back to which IRA is better. What I'm trying to get at (and what I thought poundwise explained pretty well) is let's say you have enough money to MAX OUT either a Roth or a Traditional. You can only put so much into an IRA per year. Yes, you'd have to have $5,750 to max out a Roth with your example at 15% tax bracket, but you can't put this much into a Traditional IRA so it doesn't do you any good.

So I'd rather have $5,000 growing tax free than tax deferred.

Now if you DO NOT have enough money to Max out a Roth IRA, then a Traditional might be better for you.

[Broken Arrow]

Re: Ques. on regular v. Roth IRA

This is probably one of the best IRA threads I've read so far.

However, and I freely admit I am not an expert in this subject matter, but I believe the bottom line is what jesse/jmjj said: If you think you'll end up paying more in taxes later, compared to what you're paying now, then the Roth would be the better route to take.

[sweeps]

Re: Ques. on regular v. Roth IRA

I used this example in another thread a while back:

Let's say you have $1,000 to invest in your retirement plan this year. Let's also assume you'll let it grow for 10 years at a 10% annual growth rate, and that your tax rate now and at retirement is 20%. If you choose a traditional IRA, the money goes in before taxes, so you get to invest the full $1,000. If you run the numbers in Excel, it grows to $2593.74. When it's time to withdraw, you pay the 20% taxes leaving you with $2075. If you choose a Roth IRA, the taxes are taken out up front allowing you to invest $800. That amount grows to -- you guessed it -- $2075 when it's time to withdraw.

For this particular situation, I agree, the OP should probably choose a Roth because his effective tax rate right now is low -- he might as well take the tax bite now. But the Roth is not always the optimal choice.