Which Is Better – Traditional or Roth Retirement Accounts?

One of the most common retirement planning questions we receive from clients of all ages revolves around traditional and Roth retirement accounts. In this post, we’ll provide some of the main differences between these kinds of accounts, and some of the strategy involved with deciding which you should use.

The key difference between these two account types is how your contributions and withdrawals are treated from a tax standpoint. With traditional retirement accounts, you generally receive a tax deferral of the amount you contribute. For example, if you were to contribute $6,000 to one of these accounts, your taxable income in that year would be reduced by $6,000. But this is a deferral of tax, meaning any funds you withdraw from this account type in the future will be taxed as if it were income.

For Roths, you do not receive a tax deduction on your contribution, but you typically won’t have to pay tax on what you withdraw from the account in your later years. Using the example above, your taxable income would not be reduced by your $6,000 contribution, but those funds and the associated growth would be tax free forever in most cases.

Another important difference between the two accounts is who is eligible to contribute. For IRAs, there are phase-outs, which may limit or eliminate your ability to contribute to these account types based on how much money you make in that year. As an example, if you are single, have income of $200,000 in 2021 and have access to an employee sponsored plan (such as a 401(k)), you will not be able to contribute to a Roth IRA, and any contributions to a traditional IRA will not receive the tax deduction.

The full description of these limits can be found on the IRS website here: IRS – Income ranges for determining IRA eligibility change for 2021

So, what’s the right account type for you? Well, it depends!

If you are certain to have lower income tax liability at the time you are withdrawing funds from your retirement account, the best choice would likely be a traditional retirement account. That way you save the most in tax now and will have to pay less later. Conversely, if you are early in your career and expect your income to grow in the future, Roth contributions might make the most sense.

Since we can’t know what the tax code will look like decades down the road when you are likely to begin making withdrawals from your retirement accounts, it’s a good idea to have both traditional and Roth assets so you have the flexibility to navigate and optimize your taxes in retirement. This might even mean it makes the most sense to split your contributions between the two account types in the same year.

If you take away only one nugget from this post, it’s that the right answer to whether you should contribute to a traditional or Roth retirement account is completely unique to your situation. This is where a competent CPA or financial advisor can help. Also keep in mind that these tax provisions can change wildly every year (thanks Congress). While this article was written in early 2021, many changes may have taken place by the time you smartly stumbled across it.