Is a Roth or Traditional IRA Better?

Investing in an individual retirement account (IRA) is a great way to save for your retirement, especially as an add-on to other tax-advantaged retirement plans like 401(k)s. There are two main types of IRAs: traditional IRA and Roth IRA. While both have their advantages and disadvantages, choosing between them is a decision that should be made in the context of your personal financial goals and circumstances. In this article, we’ll discuss the pros and cons of each option and help you determine which one makes the most sense for you.?

Traditional IRA vs. Roth IRA: An Overview

A?traditional IRA?is a tax-deferred account that allows you to contribute pre-tax dollars and reduce your taxable income for the year of contribution. Your contributions, as well as any gains, are then taxed when you withdraw the money during retirement. On the other hand, a?Roth IRA?is a tax-free account that allows you to contribute after-tax dollars, meaning your contributions will not be tax-deductible. The flip side to this is that your contributions grow tax-free, and you will not pay any taxes on your withdrawals during retirement.

The?contribution limits ?for both traditional and Roth IRAs are the same, $6,500 in 2023 with additional $1,000 catch-up contributions for those over age 50. But a big difference between the two is that?a traditional IRA requires minimum distributions starting at age 73 whereas Roth IRAs do not have this requirement .

Personally, I tend to favor the Roth IRA, but as with most things in financial planning, there is a lot that depends on your own circumstances. Let’s dive deeper into the situations that would make a traditional IRA preferable over a Roth, and vice versa.

Why Choose a Traditional IRA?

The vast majority of people will be in a lower tax bracket when they retire than they are right now. In this case, it may make the most sense to contribute to a traditional IRA. For instance, imagine you are currently earning $150,000 as an attorney who files married filing jointly. This puts you in the 24% tax bracket. Now imagine that your income drops to $55,000 in retirement, putting you in the 12% tax bracket. Would you rather have paid a higher rate now, or received a current-year tax deduction and paid the lower rate in retirement? Most people will opt for the current year’s tax deduction and contribute to the traditional IRA.

Traditional IRAs can also make more sense if your income is higher than average and you want to reduce your tax liability. This situation is very common for?attorneys ?and can help you manage your current year’s tax bill.

But the truth is, analyzing the tax benefit of a traditional versus Roth IRA is not as simple as the previous two examples would imply. That’s because you have to pay taxes on both contributions AND earnings in retirement when you contribute to a traditional IRA. That means the benefit from the traditional IRA is only more valuable in the long run IF you commit to investing the tax savings you earn from the deduction to make up for the tax hit you’ll take in retirement. That’s a pretty big “if.” Many people think they will invest the extra funds, but don’t actually stick to the plan. So, choosing a traditional IRA could end up costing you more in the long run.

Why Choose a Roth IRA?

Let’s take a look at the Roth. If you believe you will be in a higher tax bracket in retirement, a Roth account may be a better option. Roth IRAs also make sense if you believe that taxes in general will be higher by the time you retire. For instance, some believe it’s only a matter of time before Congress raises taxes again, and they would rather pay based on today’s rates rather than the unknown rate of the future. Essentially, utilizing a Roth IRA can be seen as pre-paying your future tax liability. Some people prefer the certainty that their taxes are already paid.

Additionally, if you have a particularly low-income year, then it makes sense to contribute to a Roth IRA or utilize a Roth conversion since you are in a lower tax bracket than is typical. By paying taxes on the contributions now, you’ll avoid paying taxes on the withdrawals (both contributions AND earnings) in retirement.?

Why Not Both?

Oftentimes the traditional versus Roth IRA conversation overlooks the idea that you don’t have to choose one or the other! And usually it’s best to have a combination of both pre-tax and after-tax retirement savings.?

Think about it this way: What would happen to your spouse’s tax liability if you were to pass away? Your?Social Security ?income will be reduced, which means, more than likely, your spouse will have to withdraw more funds from your retirement accounts at the exact time their tax bracket will move from married filing jointly to single. So, your spouse’s overall income will drop, yet their tax liability can actually go up because of the change in filing status. In this circumstance, it would be very helpful to have a source of tax-free (Roth) funds from which to draw.

How We Can Help

Choosing the right combination of after-tax and pre-tax retirement funding options is an important decision that depends on many factors. At?Wurz Financial Services , we’re here to help attorneys and law firm owners navigate retirement planning and make well-informed decisions about their savings.?

Schedule a no-obligation consultation, and together let’s find out if we’re the right people for you to depend upon during your journey to a comfortable retirement. Contact us at 859-291-9879 or?[email protected] ?today!?

Also, join us at one or all of our free webinars:?

• Social Security 101 : The 3 Rules to Maximize Your Lifetime Retirement Benefits!?
• Will I Have Enough to Retire?
• Retirement Planning Strategies for Solo & Small Firm Attorneys?

About Darren

Darren Wurz is a fee-based financial advisor and co-owner of Wurz Financial Services, where he operates the Northern Kentucky/Cincinnati office. He is a CERTIFIED FINANCIAL PLANNER? professional and has a master’s degree in financial planning from Golden Gate University. Darren specializes in serving the unique financial planning needs of attorneys and law firm owners. He is the host of?The Lawyer Millionaire?Podcast ?and author of?The Lawyer Millionaire: The Complete Guide for Attorneys on Maximizing Wealth, Minimizing Taxes, and Retiring with Confidence , published by the American Bar Association.

Darren is a member of the American Bar Association and the Financial Planning Association. He is also active in his local community as a member of the Northern Kentucky Bar Association, Cincinnati Bar Association, Covington Business Council, and Northern Kentucky Chamber of Commerce. To learn more about Darren, visit TheLawyerMillionaire.com .