ROTH vs Regular IRA

[NetSkyBlue]

At what point does it become beneficial to use a regular IRA over a Roth?

For example, I will be in the 25% federal tax bracket this year (up from last year), and the outside of that bracket is currently at $85,650. I can't imagine ever exceeding this bracket from normal income (given where I live and what I do), but it's quite possible in retirement I could be down a bracket. (I'm still in the lower end of the bracket).

It's even possible I could go back down a bracket (or hover right around the line) in a few years when I reach my savings goals and don't have to work a part-time job. And who knows what they'll do to the brackets in future.


Last year I was all for the Roth. Now I'm not so sure.

[disneysteve]

I'd rather pay taxes today at historically low rates and not gamble on what those rates might be 20 or 30 or 40 years from now. If you qualify, I'd take the Roth.

[JuniorTT]

When I was in my 20s I blindly followed the advice of "use a Roth when you're young since your salary is only going to up and tax brackets in general have only one way to go (up)." Well here I am in my early 30s and DW is staying home with DD so we are down from the 28% bracket to the 15% bracket. So, at first glance, Roths were not the best answer for us in our 20s.

But, with that said, we've got a couple hundred thousand in rollover IRAs that we have started converting to Roths and will continue to do so over the next 5-10 years. So as long as we can keep filling up the 15% tax bracket with rollover IRA conversions then I don't regret the Roths in our 20s. But if we ever get to a point where we've converted all IRAs and don't have anything left to fill our 15% bracket, then I'll offically call Roths in our 20s a bad move.

Maybe someday I'll have to quit my current job so I can rollover and then convert my 401k while still in the 15% bracket...lol.

[kork13]

There really are no hard and fast rules for this, because future tax rates are a huge unknown factor.

That said, if you're in the 15% bracket, Roth is almost certainly your best choice. In the 25% bracket, it's more of a judgement call... Another consideration, would it be possible for you to contribute enough to a deferred account (IRA or 401k) to bump yourself down to the 15% bracket? That could be one reason to emphasize deferred over a roth account.

Over the next year or three, I'm expecting to cross into the 25% bracket, and I'm planning to still max my Roth IRA, but split my 401k-type account between deferred and Roth contributions, basically using the deferred contributions to keep myself in the 15% bracket as long as possible. Otherwise, I'm still focusing on the Roth accounts. As DS said above, I'd rather pay taxes now at rates I know are historically low than take a shot in the dark about what taxes will be in the distant future (I'm not retiring for ~40 years).

Truly, I think if you're in a situation where the difference is close enough that you're unsure of what method is best.... it probably won't make a significant impact on your retirement years. I mean, do you really see yourself sitting in a rocker in retirement wishing, "If only I had saved in my Roth instead of my deferred IRA..."

Bottom line, though, the absolute best possible strategy can be summed up in one word: SAVE. As long as you're saving, regardless of the account's tax treatment, you're doing good for yourself.

[MonkeyMama]

In the 25% bracket, I could really flip a coin. Heck, I contributed some to our regular this year (in 15% bracket). Of course, there is more to this story - my tax rate was higher once you consider deductions that increased with a lower AGI, plus state taxes. If I really only paid 15% tax total, I would have just done 100% ROTH.

In general, I think it largely comes down to cash flow. If you are going to max out either way, just do the ROTH. 25% is a low tax bracket in the grand scheme of things. ROTHs also have other advantages. You'd also be surprised how high your taxes can be in retirement (my retired tax clients tend to pay fairly high taxes versus younger folks, for a variety of reasons).

On the flip side, things change through life and you might have other low-tax opportunities. Our tax rate was sky high when we were younger and I didn't see the point of the ROTH. BUT, my spouse has since been unemployed many years. So we took the immediate tax break when taxes were high (contributed to regular IRAs and 401ks), and rolled a lot over to ROTHs in lower income years. Win-win. The "net" was still a decent tax break up front (since we saved about twice the amount taxes that we ended up paying). OF course, if you think you will work your entire life and never have an "off" year - never take a year off to have children or care for your parents, never be disabled, and never be unemployed... It seems like most people will have income fluctuations at some point in their lives. I've got a number of clients who are good savers, who took advantage of these times to convert big chunks of retirement funds over to ROTHs.

I wouldn't fault anyone for just taking the 25% tax break now. The future is terribly unknown - there is something to be said for a sure thing. Taking the tax break now is a sure thing.

[kv968]

As everyone said, it depends on your current tax situation and what you think the future will hold. Unfortunatley, no one knows what the future tax rates will be or what bracket we'll definitely fall in. At least not for us that are quite a ways from retirement.

With that, I tend to look at trad./401k vs. Roth as a way to diversify that tax risk. Save a little now, save a little later. I also look at the difference with not just with how I put the money in, but how I'd take it out. As some asked, they're going to start falling into the 25% tax bracket and would it be good for them to contribute to a traditional to keep them out of it? I kind of reverse engineer it and look at it more as when I'm in retirement I'd like to use all taxable money (i.e. 401k, SS, pension, etc...) UP to the 25% tax bracket and then start taking distributions from the Roth so I don't pay the 25%. Granted, that's assuming the rate structure would be the same as it is today (which I doubt) but still going along those lines.

[dczech09]

First thing you have to realize is that we are on a "marginal tax rate" system. Thus when you are in the 25% bracket, not all of your income is taxed at 25%.

Under 2011 tax rules, for a single person, $34,500 is the cut off line for the 15/25% bracket.

So someone making $50,000 would have...
$34,500 subject to 15% tax
$15,500 subject to 25% tax

If said person was looking at contributing $5,000 to a IRA and they wanted to choose between the Roth or Traditional, they would ask themselves this...

Since the full $5,000 would be subject to a 25% tax rate, would I want to pay 25% today in hopes of saving at a higher bracket tommorrow. Or would I rather pay no taxes today in hopes of paying less than 25% in the future.

So it is basically a gamble. We do not know what the tax system will look like 30 years from now, much less even 2 years from now. The landscape could totally change.

Whether or not taking a the tax deduction of the Traditional IRA today will drop us into a lower tax bracket is not really relevant to our decision making. All we are concerned about is the tax treatment of our contributions to the IRA.

With that said, I would argue that the Roth almost always wins- especially over the long term. Over the long term, being able to build up a tax free nest egg will supercede the benefits of using the government's money to compound returns.

Also, who is to say that the government will not change the IRA rules in the future. For all we know, some stupid senator with a thirst for tax dollars may propose killing the Roth IRA. If that happens, they would likely grandfather the existing Roth holders. So I like being in the Roth IRA early.

Just some thoughts of mine

[AccountantSalary]

You also have to think about what they might do to the Roth in the future. With the budget the way it is, it wouldn't surprise me if they find ways to tax withdrawals in the future.

[jpg7n16]

At what point does it become beneficial to use a regular IRA over a Roth?

At the point when you expect your withdrawals will taxed at a lower rate than they are today.

Something I've been mulling over is that 401k contributions and regular IRA contributions both come out of your top marginal tax bracket. But withdrawals begin in the lowest marginal tax bracket, and are on taxable income (meaning after deductions, exemptions, tax credits, etc.). You don't get to apply deductions and credits when the income isn't taxable.

The tax bracket system doesn't work as a flat tax. In other words, you don't just look at what bracket you fall into and say "oh I'm in the 28% bracket and made $100k, therefore I owe $28,000 in taxes." thats not true. The first portion of your income is taxed at a low rate, the next portion at a slightly higher rate, the next at a higher rate, etc until you run out of income.

The same will hold true for your 401k/regular IRA withdrawals.


But in the end, it's best to have both pretax and aftertax retirement savings. If you're 100% in pretax money, you'll be forced to pay whatever the rates are at that time. You need the money and you have no choice. If you're 100% in a Roth IRA, you miss out on all the deductions and exemptions and lower brackets.

[dczech09]

Something I've been mulling over is that 401k contributions and regular IRA contributions both come out of your top marginal tax bracket. But withdrawals begin in the lowest marginal tax bracket, and are on taxable income (meaning after deductions, exemptions, tax credits, etc.). You don't get to apply deductions and credits when the income isn't taxable.

Very good point.

It would take a very thorough analysis to determine the best structure based on that.

I contribute $5,000 per year, ordinarily subject to a 25% tax. But say since it is in a Roth, I pay the taxes today. If I went through a Traditional, then I would defer the taxes to a 15% rate.

Luckily though I have so many deductions today that my adjusted taxible income is just under the $34,500 bracket line.

Still, that is a fantastic point.

[kv968]

The tax bracket system doesn't work as a flat tax. In other words, you don't just look at what bracket you fall into and say "oh I'm in the 28% bracket and made $100k, therefore I owe $28,000 in taxes." thats not true. The first portion of your income is taxed at a low rate, the next portion at a slightly higher rate, the next at a higher rate, etc until you run out of income.

The same will hold true for your 401k/regular IRA withdrawals.


But in the end, it's best to have both pretax and aftertax retirement savings. If you're 100% in pretax money, you'll be forced to pay whatever the rates are at that time. You need the money and you have no choice. If you're 100% in a Roth IRA, you miss out on all the deductions and exemptions and lower brackets.

That's why I'm saying with withdrawls it's best to pull from a tax-deferred account (401k/trad.) until you reach that level (i.e. 25%, 28%, etc...) and then start taking money out of the Roth. That way you won't be charged that higher marginal rate.

[disneysteve]

You also have to think about what they might do to the Roth in the future. With the budget the way it is, it wouldn't surprise me if they find ways to tax withdrawals in the future.

I don't believe they will ever change the tax treatment of money already in Roths. That would cause a serious revolution. They may eliminate new contributions but they'd have to grandfather in existing accounts. Otherwise they'd be double taxing the money.