There are advantages and disadvantages to both.  What I want to accomplish with this article today is to show how if all things are equal, they will get you the same result long term.  It is your tax planning that needs to be the key factor in this.

This example will be simple.  I’m going to say that you make an income of $5000.  We will also assume a constant tax rate of 25%.  This example will work with whatever numbers you choose for your own situation.  We will compare putting all of it into a Roth and all of it into a traditional IRA.  We will also assume that you get your living expenses paid from another source for sake of simplicity.

Let’s start with the traditional IRA.  If you make $5000, you can put all of it into the traditional IRA.  When doing that, you will have an immediate balance of $5000 in your IRA.  After 10 years, let’s say the money doubles and you now have $10,000 in the IRA.  When you take it out (we will assume you are taking all of it out at age 60), you will have to pay 25% tax on it and your balance will be $7500.

Now, let’s do that same example with a Roth IRA.  After you make $5000, you will have to give 25% of it to the government for income tax as there is no deduction for a Roth.  So, you will then start with a balance of $3750.  If it doubles after 10 years just like the traditional IRA, your balance will be $7500. In this example, you will not have to pay any taxes when you make a withdrawal. So, the balance will be the same as a traditional IRA.  So, if tax rates stay the same, it makes no difference weather you choose a Roth or a Traditional IRA.

So that leads us to the question as to how can you use one or the other.  I like to look at a few factors….

1.  What will your tax rate be upon retirement?  If you believe that you will be in a lower tax bracket in retirement, then that would give the advantage to a traditional IRA.  With a traditional IRA, you will get a deduction at a higher rate, but take money out of the IRA at a lower rate.
2. Will tax rates increase?  If they do, then a Roth may be more advantageous.  When you take money out of a Roth, it is tax free.  So, if tax rates increase, then a Roth would protect from that happening. 
3. What will your deductions be?  Let’s say that you are a regular tither for your church.  When you give money, it is tax deductible.  So, if you plan on tithing during retirement, you can get a double deduction.  The way you could do that would be to deduct the money coming into the traditional IRA while you are working.  Then, when you take it out to tithe, you can deduct the income tax as it was a tithe.  This concept could also apply to mortgage interest, or anything else that you would deduct.  In this case, the advantage would go to the traditional IRA.

As you can see, there are many factors to consider when choosing how you could use both tools.  These are just a few.

If you have any questions on this or anything else in the financial realm, feel free to email me at mtosaw@rcmfs.com.