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Classic Traditional vs Roth IRA Clarification

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  • Classic Traditional vs Roth IRA Clarification

    So...after the better part of a decade hearing about Roth IRA income limits and learning how to contribute to a Backdoor Roth wife and I are finally at the point where we can put all this information to use. I feel like the Roth is very much favored compared to the Traditional IRA. However, looking at the options, I honestly am a little confused as to why Roth is "better" than the Traditional.

    I understand...

    Roth: after tax contributions, tax free gains in retirement, ok to borrow principal, no RMD

    Traditional: pre-tax contributions, tax upon distribution, RMD

    ...but aren't we always going to be in a lower income bracket when we retire? I get the advantage of contributing to a Roth IRA when in medical school or just starting out in the 15%/25% tax brackets but what's the advantage of paying 28%/33% tax on the money now compared to retirement when we'll most likely be in say the 25% bracket? Aren't I just over paying now? Maybe I'm thinking about retirement wrong but I usually plan to have say 70% of my income or something like that - not, for instance, 130%. Again, at best, I'd think we stay in the same tax bracket, not go into a higher bracket when we're retired...I also don't anticipate ever borrowing from my Roth so that's not necessarily appealing to me either...

    Why not take advantage of the tax deduction now and just slowly convert my traditional IRA into a roth IRA (as suggested here... when I'm retired to avoid the RMD if that's really the concern? (Keeping the minimum 5 year holding period in mind)

  • #2
    I have been wondering the same thing, and in the end I feel if you put your contribution into roth and let it grow long enough time, the large untaxed growth will eventually outweigh the lower tax bracket in retirement (or you might end up in a higher bracket because you have lots of income from your accumulated investment post retirement who knows). I'd like to see if others can confirm if my assumptions are correct:

    Assume putting in 100 dollars in either TIRA or ROTH, and growing to 800 after 30 years, and in a 35% marginal bracket pre-retirement and 15% post retirement.

    Traditional IRA: pays no tax initially, but pays tax on whole $800 after retirement X 15% = $120

    Roth: pays tax initially on $100 X 35% = $35, but never pay tax ever again

    so I'd rather pay $35 initially than $120 at retirement. Now imagine multiple that by a hundred times maybe, if you are contributing $10k to roth this year. You'd pay $3500 now instead of 12000 in 30 years. Of course the money today is worth more than the money in 30 years but.

    Is that the correct assumption?


    • #3
      Most of us can't deduct traditional IRA contributions because we have employer accounts and our incomes are too high. Hence the backdoor Roth (traditional contribution, not deducted, and converted to Roth) is the only way to make the IRA contribution tax-advantaged because non-deducted traditional IRA contributions aren't better than a standard taxable brokerage account.


      • #4
        Most people here are using a Roth after they have maxed out their other retirement options.  It's a both-and not an either-or decision.


        • #5
          Planning doesn't happen in a straight line, first of all, and there is absolutely no guarantee that your tax rate at retirement will be lower than the current - that's just an assumption based upon what we know today, in the present. Maybe, maybe not. Personally, I prefer Roth if possible, for several reasons:

          1. Contributing today forces you to pay the taxes whereas most people don't invest the taxes saved from a deduction. If that were always the case, that would tilt the deduction a higher lower for me.

          2. TIRAs require RMD's at age 70.5 and Roth IRAs do not. The forced additional income from TIRAs will cause many retirees to pay higher taxes.

          3. The additional income from RMD's will not only be taxed, but will cause other tax attributes to come into play. While that happens today, you won't be dealing with additional taxes on SS income until retirement.

          4. Roth IRAs are great for estate planning. Many TIRAs will be passed to future generations who are marginally higher tax brackets, not the low projected tax bracket of retirees.

          Ideally, you should convert to Roth IRAs in bear markets and corrections. See Roth IRA conversions part 2 of 2: When and how to convert

          A small edit to the OP re: "ok to borrow principal". You cannot borrow from Roth IRAs; you can remove your principal, but you cannot pay back your principal. Once it comes out, it stays out.

          Our passion is protecting clients and others from predatory and ignorant advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087