I’m often asked, “Which is best, a Roth IRA or a traditional IRA?” There’s no one right answer.
Which option you choose depends on your goals, and it depends on what you think your income will be like in the future. In theory, there’s no difference between the eventual returns. In practice, there are a variety of factors that can affect your decision, of which tax rates are perhaps the most notable.
Walter Updegrave at CNNMoney — one of my favorite money experts — recently answered this very question:
The tax rates you face prior to and at the time you withdraw your money can also determine whether a traditional IRA or Roth is a better deal.
Generally, if you expect to be in a lower tax bracket at retirement than you were when you made the contribution, then the traditional IRA is the better deal since you’re effectively avoiding tax on your contribution and earnings when the tax rate is higher and paying it later when the rate is lower.
If you expect to be in a higher bracket when you withdraw the money, then Roth is the better choice because you’re paying tax at a lower rate and avoiding tax when the rate would be higher.
And if you expect to stay in the same bracket, the Roth is the better choice because of its inherent advantage of effectively sheltering more money. As a practical matter, however, we can’t always know whether we’ll be in a higher, lower or the same tax bracket in the future.
Ultimately, Updegrave believes that everyone should consider putting at least some money in a Roth IRA. “Even if it turns out in retrospect that the Roth wasn’t the best deal,” he writes, “having access to a pot of tax-free cash can still give you peace of mind and a bit of maneuvering room in retirement.”
For more information about individual retirement accounts:
The GRS Introduction to Roth IRAs series
Part 0: How compound returns favor the young
Part 1: What is a Roth IRA and why should you care?
Part 2: How to start a Roth IRA (and where to do it)
Part 3: Which investments are best for a Roth IRA?
Part 4: Questions and answers about Roth IRAs
October 21st-27th is National Save for Retirement Week in the United States.
[CNNMoney: Ask the expert: The best retirement deal]