Choosing a Roth vs. Traditional IRA: It’s About More Than Just Taxes
August 02, 2023
By Andi McNamara, CFP®
Vice President, Director of Financial Planning
Washington Trust Wealth Management
Is a Roth or Traditional IRA best for you? It’s all about asking the right questions.
A typical search for “Which is better: Roth or Traditional?” will yield thousands of results and multiple calculators, primarily based on comparison of your current versus retirement tax bracket. It is an oversimplified approach: If you’re in a higher bracket now, take the tax deduction and choose Traditional; if you are expecting a higher tax bracket in retirement, pay the taxes now and choose Roth.
Spoiler alert: Not every financial question is a math equation, and your feelings and confidence about your money decisions can be as important as the numbers. A decision that may save a few tax dollars but leaves you anxious and unable to sleep is not the best one for you.
Traditional IRA |
Roth IRA |
|
Funded with |
Pre-tax $ |
After-tax $ |
Contribution Limits (for 2023) |
$6,500 ($7,500 if age 50+) |
$6,500 ($7,500 if age 50+) |
Taxes |
Contributions are tax-deductible Withdrawals are taxable |
Contributions from after-tax dollars; no deduction Tax-free withdrawals (after 5 years) |
Income Limits for Contribution Eligibility |
None |
< $153,000 (single tax filers) |
Required Minimum Distributions (RMDs) |
Required in your 70s; start date varies based on birthdate |
None |
Penalty for Early Withdrawal |
10% on all withdrawals unless exception applies |
Return of contributions penalty free; everything else 10% unless exception applies |
Comparison Tablei
So, what questions can you ask to ensure you’re making decisions that support both your short- and long-term goals? Here are a few to consider:
Who will get the money after I die?
If you have more money available than you will likely spend, consider who will get the remainder. If it’s a charity, that beneficiary is tax agnostic (they won’t pay taxes on the money), so Traditional or Roth does not matter. But your children, grandchildren, or other beneficiaries will pay income taxes on the money. A Roth IRA is far more desirable for your heirs since there are no income taxes when they inherit the money.
Are my accounts tax diversified?
Tax diversification in your investments—how much you have in traditional retirement accounts (portfolio income tax deferred until withdrawal) compared to taxable accounts (pay dividend and interest income tax as you go) and Roth (portfolio income not taxable and not taxable at withdrawal)—allows you flexibility for financial planning in retirement. For example, some years you may want to avoid generating additional IRA income that is fully taxable to offset other financial transactions, such as selling a real estate property or a stock that generates a large capital gain. This flexibility is also beneficial for years with large outlays of cash, like paying for college or a wedding, taking the family on a big trip, or buying a second home.
Should I have both Traditional and Roth?
Yes! We recommend you get at least some money into a Roth retirement plan as often as possible. If you are able to contribute to a Roth IRA directly or do a strategy referred to as a Backdoor Roth IRA conversion (contribute to your IRA without a tax deduction and convert it to a Roth), you should. The best of both worlds is a strategy referred as a Mega Backdoor Roth Contribution within your employer-sponsored retirement plan like your 401(k), if available because you can contribute on a pre- and post-tax basis. First, max out your traditional, pre-tax contribution and get the full tax deduction. Then, contribute more using your after-tax option and have the custodian do an in-plan conversion to your Roth 401(k) source. Not all custodians have this option, but it is extremely powerful if they do.
Mega Backdoor Roth Contribution Example
You are 55 years old and are allowed a catch-up contribution, which brings your total pre-tax contribution amount to $30,000 in 2023. Your custodian allows for the Mega Backdoor Roth Conversion, so you contribute the maximum after-tax amount,ii which is then immediately converted to Roth within the plan. Depending on your employer contribution amount, you may be able to contribute another $40,000 to your Roth source in your plan. For example: If you contribute $30,000 pre-tax and your employer contribution is $10,000, that leaves another $33,500 available for the Mega Backdoor Roth in-plan conversion.iii
Washington Trust Wealth Management is Here to Help
At Washington Trust, we work closely with you to evaluate and plan which IRA makes good financial sense for you. Using a sophisticated software platform, we can determine when and how to best take advantage of the tax benefits and savings potential and address important factors to consider, including your tax bracket, time horizon, available funds, investment preferences, and Qualified Charitable Distributions (QCDs). Working together, we can select the account that best aligns with your long-term retirement objectives.
i “Traditional and Roth Iras.” Internal Revenue Service, Traditional and Roth IRAs | Internal Revenue Service (irs.gov)
ii Your total retirement plan contribution is limited to $73,500 (including catch-up) by the 415(c) limit in 2023. The limit includes all employee and employer contributions to your plan(s). “Retirement Topics - 401(k) and Profit-Sharing Plan Contribution Limits.” Internal Revenue Service, Retirement Topics - 401(k) and Profit-Sharing Plan Contribution Limits | Internal Revenue Service (irs.gov)
iii “Rollovers of After-Tax Contributions in Retirement Plans.” Internal Revenue Service, Retirement Topics - 401(k) and Profit-Sharing Plan Contribution Limits | Internal Revenue Service (irs.gov)
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By accessing the noted link you will be leaving Washington Trust's website and entering a website hosted by another party. Washington Trust is not responsible for, nor do we control, endorse or guarantee the content of any external sites. Please be advised that you will no longer be subject to, or under the protection of, the privacy and security policies of Washington Trust's website. We encourage you to read and evaluate the privacy and security policies of the site you are entering, which may be different than those of Washington Trust.
By accessing the noted link you will be leaving Washington Trust's website and entering a website hosted by another party. Washington Trust is not responsible for, nor do we control, endorse or guarantee the content of any external sites. Please be advised that you will no longer be subject to, or under the protection of, the privacy and security policies of Washington Trust's website. We encourage you to read and evaluate the privacy and security policies of the site you are entering, which may be different than those of Washington Trust.
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