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  • Writer's pictureKelsey

Retirement: Traditional versus Roth

When it comes to retirement, we can choose to invest our money in a Traditional account, or a Roth account. I am not here to give the magic answer as to what we should do because in knowing what to do, we must decide what we believe the future holds.

From Investopedia, "with traditional, we deduct contributions now and pay taxes on withdrawals later; with Roth accounts, we pay taxes on contributions now and get tax-free withdrawals later."

When I opened my first retirement account, it defaulted to Traditional and I kept it that way the first year. One day I had a conversation with a colleague who recommended* everything should be in Roth, so I changed over all my future contributions to Roth.

*I changed having no idea what Roth was and I blindly followed their advice. While I am grateful that I did, any financial tips or advice we receive should be independently vetted through our own research

With Traditional the money is taken out of our paycheck before taxes, so our take-home pay would be more than with a Roth account. With Roth, taxes are paid before the money is transferred into our retirement, so our take-home pay will be less.

If we contribute $6,000 today and pay taxes now, in 10 years when that $6,000 is worth $8,000, we get that full $8,000 without paying taxes (a gain of $2,000 on our contribution).

If we contribute $8,000 into a Traditional account, we would need to pay taxes 10 years from now on that full $8,000, resulting in take-home pay closer to $7,000.

Based on the definition of Investopedia above and this example, you may be wondering then, why wouldn't everyone do Roth and pay taxes now on $5,000 so we can get $8,000 later with no taxes?

Let's explore more...

Herein lies the decisions that only each of us can make for ourselves.

  • Do we need more money right now for expenses, while still wanting to contribute to retirement? Traditional contributions lower our taxable income, meaning we pay less in taxes overall and have larger take-home pay

  • If we are making less money now and in a lower tax bracket than we believe we will in the future, it makes more sense to contribute to Roth (e.g. those early in their career in their 20's)

  • If we are in a high tax bracket and believe we will be in a lower tax bracket in retirement, it may make sense to contribute to a Traditional and pay a lower tax rate in the future.

  • Do we believe the government will still allow us to take out Roth contributions tax-free in 30 years (or however long it is until our retirement?)

  • Republicans typically lower tax rates, while Democrats typically raise them, so maybe we contribute via Roth and pay taxes at lower rates when Republicans control Congress, and contribute Traditional when Democrats are in office and tax rates are increased

  • Do we believe tax rates will continue to go up in the future or go down?

As you can see, there are many things to consider when determining a Traditional or Roth contribution. A Certified Financial Advisor would be able to guide you on your unique situation and plans (Do you plan to stay working full time? Becoming a stay-at-home parent? Starting your own business?)

Our tax professional can also assist if we wait until year-end to contribute to an IRA once they look at our taxes. While 401k contributions end each calendar year, with an IRA we have until we file our taxes to contribute for the prior year. That $6,000 contribution can have an impact on how much we owe, or get back, on our taxes. Our tax advisory can project both options (contributing $6000 pre-tax versus post-tax) and recommend the best strategy to optimize taxes for that tax year.

For me, some years I have contributed 100% Roth, others 100% Traditional. Last year I did a 70/30 mix. Each year I looked at my current income and tax circumstances, and my expenses, and decided the best approach for ME. I encourage you to consider the bullets above, and what works best for YOU.

The only wrong answer is not saving for retirement.


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