So, how do you decide whether a traditional or a Roth IRA belongs in your retirement plan?
If your income is too high to deduct regular IRA contributions, the Roth IRA is a great addition to your retirement savings.
Even if you can deduct your IRA contributions, the Roth has clear advantages, primarily the fact that there's no mandatory withdrawal schedule to worry about and that money in a Roth can go to an heir tax-free.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
You also won't have to worry about tax-free withdrawals triggering extra tax on your social security benefits.
What about the financial advantage of getting tax-free versus taxable withdrawals?
Believe it or not, there's no guarantee that -- when all else is equal -- the Roth will beat the regular IRA. You need a crystal ball as much as a financial calculator to know whether it makes sense to give up tax deductions today in exchange for tax-free income tomorrow.
It really depends on what your tax bracket will be when you retire. If you're in a lower tax bracket, the regular IRA will prove to have been a better choice; if you're in a higher tax bracket, the Roth will shine.
An apples-to-apples comparison
Assume that you deposit $4,000 a year in a regular IRA and just $3,000 in a Roth -- because that's all the regular IRA really costs you if you're deducting contributions in the 25% bracket.
Assuming the money in the accounts earns at the same rate, at the end of any period, the spendable amount in the accounts will be identical.
Sure, the deductible IRA will hold more money. But you'll owe tax on withdrawals. Assuming a 25% rate, the after-tax amount will be the same as the tax-free amount coming out of the Roth IRA.
As noted, however, there is a way to give the Roth a big advantage. Put a full $4,000 into the account each year rather than a stunted $3,000, and increase your contribution as the limits rise.
But what if you find yourself in a lower tax bracket in retirement? Then you might be kicking yourself for passing up regular IRA deductions back in the bad old days of high income tax rates. Assuming there will still be an income tax when you retire (a pretty good bet), how can you know whether you'll be in a higher or lower bracket?
You can't. In the past, it was generally assumed that retirees would fall into a lower tax bracket because they'd have less taxable income. Now, however, it's increasingly likely that retirees will maintain their income levels.
Ironically, because opting for a Roth will reduce taxable income in retirement, it's more likely that you'll be in a lower bracket (which is a minus for the Roth); conversely, using a regular IRA will boost taxable income in retirement, possibly pushing you into a higher bracket (which is a minus for the regular IRA).
How to Get Your IRA up and Running
-
What Is a Qualified Charitable Distribution (QCD)?Tax Breaks A QCD can lower your tax bill while meeting your charitable giving goals in retirement. Here’s how.
-
Embracing Generative AI for Financial SuccessGenerative AI has the potential to reshape how we approach learning about and managing our personal finances.
-
COVID Hospitalization Rates See an Uptick As Winter Looms — The Kiplinger LetterThe Kiplinger Letter A new Omicron booster is available, but the elderly are still at risk and winter is right around the corner.
-
Will Weight-Loss Drugs Spike Medicare Costs?: The Kiplinger LetterEconomic Forecasts Lawmakers are trying to get weight-loss drugs like Wegovy covered by Medicare. Long-term savings are possible, but it could cost the program $27 billion.
-
Greenland, U.S. Plans to Boost Tourist Economy: Kiplinger Economic ForecastsEconomic Forecasts A U.S. congressional effort could see some Canadian visitors get longer stays, meanwhile, Greenland bids to be the next vacation hotspot.
-
Medicare Drug Price Negotiations Latest: Kiplinger Economic ForecastsEconomic Forecasts Medicare drug price negotiations: Early signs have emerged of how these key talks will be handled.
-
Forces That Affect Your Estate Planretirement From probate and ownership division to the taxing arm of Uncle Sam, here are four things that can influence what happens to your belongings.
-
Tapping Your IRA in Retirementretirement You can cash in your IRA all at once, but doing so could subject you to an enormous tax bill. You'll probably do better tax-wise by taking out as little as necessary each year.
-
Make a Plan for Your Retirement Savingsretirement The first step to effectively using your 401(k) is to assess your retirement needs.
-
What to Ask Before Buying an Annuityinsurance If more people understood these confusing products, fewer probably would be sold. Find out what you need to know.
