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Grading a Roth vs. traditional IRA

Whether to invest into an ordinary tax-advantaged employer plan and IRA personal accounts versus investing in “Roth” IRA and tax-advantaged employer plan retirement accounts is not always a straightforward decision.

The choice on the trade offs is one of the most complex decisions of do-it-yourself financial planning. A lot of personal finance issues can affect whether a ordinary IRA or tax-advantaged employer plan account contribution versus a Roth tax-advantaged employer plan or IRA personal account contribution decision would be better.

In most circumstances making investments into a traditional IRA or tax-advantaged employer plan retirement accounts is the better decision, when those contributions would be currently tax deductible.

Over a lifetime the analysis is quite complicated. Rules-of-thumb are not sufficient to analyze the many important personal financial factors. The preference is not just about present versus future tax rates. Instead, the choice requires a comprehensive financial projection and analysis of the family’s life cycle savings, taxes, and assets.

(Look here for a comprehensive Roth retirement planning calculator that makes automatic this traditional IRA or tax-advantaged employer plan account versus investing in “Roth” IRA or tax-advantaged employer plan personal account calculation.)

Whether or not a person will save enough to invest efficiently over their lives is most important in the Roth retirement account versus the “currently tax deductible” regular retirement account additional investment decision.

When a person does not earn a sufficiently high income, does not control consumption to save a lot, cannot dramatically reduce investment expenses, and/or cannot build up a large enough investment asset portfolio, then that investor will not have to worry about being in high income tax rates when retired — whether or not federal and state tax have changed by retirement. If a person does not have sufficiently large assets and income when retired, then the present tax savings an investor can get from deciding on a traditional retirement account contribution will tend to be more economically advantageous over a life cycle.

Note: This article ONLY talks about financial situations where the person has the choice of making a “deductible against current income taxes” traditional IRA or 401k contribution versus a currently “not deductible against current income taxes” Roth IRA or 401k additional investment. If you cannot get the deduction this year but can make a Roth deposit, then the Roth deposit is better.

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