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Which is Best: A Roth or Traditional Retirement Account?

Money Girl details what to know when choosing between a Roth or traditional retirement account - no matter if you use an IRA, a retiremment plan at work, or both. Plus, get the Retirement Account Comparison Chart to see how all the accounts stack up.

By
Laura Adams, MBA
6-minute read
Episode #393

If you already own a Roth IRA, and your income goes up and exceeds the annual allowable limit, you can continue to own the account with no penalty - you just can’t add new funds to it.

On the other hand, as I mentioned, there is no income limit to qualify for a Roth account at work. So you can have one no matter if you’re in an entry-level job, or happen to be the highest paid employee in the company.

See also: 10 IRA Facts Everyone Should KnowIn order to pay as little tax as possible, consider whether your income tax rate could be lower now relative to when you retire. 

Question #2: Is My Tax Rate Likely to Be Higher or Lower in Retirement?

With any kind of traditional retirement account, you get a break by delaying taxes until you take withdrawals in retirement. Roth accounts work the exact opposite way. With a Roth, you pay tax upfront, and then have no tax on withdrawals in retirement.

In order to pay as little tax as possible, consider whether your income tax rate could be lower now, relative to when you retire. If you believe that you’ll be in the same or a higher tax bracket in retirement, choosing a Roth IRA or a Roth at work, if available, is best.

The idea is that paying tax on Roth contributions upfront at a lower rate saves you money. Here are some situations where your tax rate could be higher in retirement than it is today:

  • You’re currently in an entry-level job and expect to be earning more in the future. 
  • You expect to receive an inheritance in the future. 
  • You have a hunch that income tax rates for all Americans will escalate over time.

But if you’re further along in your career and earn more now than you believe you will in retirement, you’re generally better off with a traditional IRA, or traditional plan at work. When you take withdrawals in retirement, you’ll end up paying less tax if you have a lower tax rate than you do today.  

Also, if you have a heavy tax burden from high earned or investment income, making contributions to a traditional retirement account is a smart way to cut it. You’ll get a tax deduction in the year you make traditional retirement contributions, which reduces your current tax bill.

Problem is, none of us really know what will happen in the future - especially if you’ve got a long way to go until retirement. So, if you’re not sure about your tax rates, another tip is to diversify by having both traditional and Roth accounts. That way you’ll have taxable and non-taxable money to spend in retirement.

For instance, you could put half your contributions in a traditional 401k and half in a Roth 401k. Or you might have a traditional retirement plan at work and a Roth IRA on your own, if you’re eligible.

See also: Should You Contribute to Both a 401k and an IRA?

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About the Author

Laura Adams, MBA

Laura Adams received an MBA from the University of Florida. She's an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlersbook is her newest title. Laura's previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.