Answers by Joanna: Roth vs. Traditional

Answers by Joanna: Roth vs. Traditional

Q: Should I Choose the Traditional or Roth Option?

This is a question I have been asked frequently by clients.

First, make sure you understand the basic differences between the two options. We have a great article on that topic here.

There are many different articles and calculators online that will help you figure out if the Traditional or Roth option is better for you, given assumptions about your current and future tax rates. The general rule of thumb is that you should use the Traditional option if you think that your tax rates will be lower in retirement.

However, this rule of thumb makes sense only if you put the tax savings in a separate investment account. For example, if you are taxed at a 25% rate and save $1 in a Traditional account, that $1 is no longer taxed and you’ll have an extra 25 cents to save in a separate account. I have yet to meet a single person who does this. Every person I have met takes their current tax savings and spends it. That means most people are choosing to put either $1 in a Traditional account or $1 into a Roth account, and will have the same balance at retirement (assuming they invested exactly the same amount).

The difference will be how taxes impact those accounts at retirement. If you have your retirement income in a Traditional account, every dollar that comes out will be fully taxable. So, if you take out $1 and are taxed at the 25% rate, you only have 75 cents to spend. If you have your retirement income in a Roth account, every dollar that comes out is non-taxable. So, if you take out $1, you still have $1 to spend.

A Traditional contribution makes sense if either of the following are true:

  • You are in the highest income tax bracket. But, if you are not investing the tax savings in a separate account and #2 does not apply to you, are you really getting ahead with this decision?
  • You need the tax savings to pay the bills. If you are on a very tight budget and need every dollar in your paycheck to live on, then the tax savings might be an important reason to use the Traditional contribution, because every dollar counts.

Most tax advisors I have met default to recommending the Traditional option because it saves you money today. Part of their job is to help you pay the least amount of taxes this year.  However, as a financial advisor, I am focused on the long-term success of your plan, not just the results this year. Ask yourself if either of the points above apply. If not, the Roth option might be your best choice.

If you’re still feeling unsure about which option to choose, connect with me today!

Joanna Amberger