Roth vs. traditional IRA

Roth vs. traditional IRA

Host : How should I decide how to split up my contributions?

David : This involves a number of factors, but one easy way to look at it is by using your maximum deductible IRA contribution.

Let's say you're covered by a retirement plan at work, and you make a fair amount of money, so the maximum deductible amount you can add to a traditional IRA is "phased down" to $400.

So you might want to put a deductible $400 into your traditional IRA, and put the remaining $1,600 into your Roth IRA. Of course, there are other factors.

Host : What are some of these other factors?

David : Your marginal tax rate when you contribute money to the account, and your tax rate when you pull money out of a traditional IRA.

Most people face high rates when they're working, and lower rates in retirement. This would tend to favor a traditional IRA.

But if you expect to win the lottery or otherwise be rich when you're retired, a Roth IRA might be better.

Other factors include your rate of return, and the number of years you have until retirement. And there's one other factor that's easy to overlook.

Host : What's that?

David : To what degree you'll save and invest the tax benefit associated with the traditional IRA.

Traditional IRAs give you an up-front tax break, but impose taxes on withdrawals. Roth IRAs have no up-front tax break, but impose no taxes on withdrawals.

Most analyses I've seen simply assume that the entire up-front tax benefit is invested and grows over time. If you're a diligent saver, this may be accurate, but I'd guess most people save only half of the up-front tax benefit associated with a traditional IRA.

Host : So what's the bottom line? Which is better? A traditional IRA or a Roth IRA?

David : I'd say for most people, the Roth IRA is better. But if you want to check it out for yourself, visit the luhman.org web site. We've got a freely available online calculator that will help you with this.

But the most important thing is to save money now, and saving through a deductible IRA or a Roth IRA are both great ways to save.