Pre-tax or post-tax? The eternal question. In other words, when faced with the option of the Roth IRA or the Traditional IRA, to which should you contribute?
- The key difference between Roth and traditional IRAs lies in the timing of their tax advantages. With traditional IRAs, you deduct contributions now and pay taxes on withdrawals later; with Roth IRAs, you pay taxes on contributions now and get tax-free withdrawals later.
- Traditional IRAs function like a personalized pension.: In return for considerable tax breaks, they restrict and dictate access to funds.
- Roth IRAs function more like regular investment accounts, only with tax benefits. They have fewer restrictions but fewer breaks as well.
- Whether you think your annual income and tax bracket will be lower or higher in retirement is a key factor in determining which IRA to choose.
Please keep in mind a few things. First, Roth options are not limited to IRAs. More and more, 401(k)s and other employer-sponsored retirement plans are offering Roth options. The same characteristics apply. Second, and most importantly, how do you know if your tax bracket will be lower now or during retirement, which could still be decades from now? Nobody knows, exactly, what their income will be in the future, and, certainly, nobody knows what the federal tax rate will be in the future.
Bottom line: there is no perfect answer. Some people utilize the Roth option simply for the psychological benefit of having tax-free income during retirement, even if the tax math isn’t entirely known. Accordingly, other people have a very good idea of the tax math and use (or don’t use) the Roth option. Whatever your decision is, we’re happy to discuss its impact on your financial plan.
Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.