Both Roth and regular retirement plans provide tax deferral on investment earnings. But when it comes to contributions and withdrawals, a Roth is the mirror image of a traditional plan.
With a traditional retirement plan, you deduct the money you put in, but you pay taxes on withdrawals as ordinary income when you take it out in retirement. With a Roth, you don’t get to deduct your deposits, but when you take the money out, it’s tax-free.
So when you’re asking whether a traditional or Roth is better, what you’re really asking is whether it’s better to get a deduction now or get tax-free income after retirement.
Unfortunately, the answer of which is best isn’t cut and dried.
That’s because the answer ultimately depends on factors you can’t know. For example, if you’re in a high tax bracket now but expect to be in a zero tax bracket when you retire, you’d obviously be better off avoiding the Roth and deducting your retirement contributions now with a regular plan.
If you’re going to be in the same tax bracket when you retire or a higher one, it would be best to use a Roth and pay no taxes when you take the money out.
Unfortunately, there’s no way to know what the tax tables will look like when you retire, especially if it’s far in the future.
In other words, some might argue that today’s bird in hand — a deduction on contributions — is better than tax-free withdrawals at some future date. After all, while it’s unlikely, Congress theoretically could change the rules and start taxing Roth IRA withdrawals. Then, of course, there’s also the possibility you may not live to see your golden years.
On the other hand, some might look at the state of today’s government – where tax brackets have been at relative lows, yet government continues to run a deficit – and think that there’s no help but to raise tax rates in the future. At which point you could decide that a Roth is the way to go.
But here’s the answer I most often give: Since you’re not required to fund only one type or the other, why not have both? That way you can get some deductions now, and you’ll have a tax-free source of retirement income, too.