I get the question a lot: “Which is better; a traditional or a Roth IRA?” With most things in financial planning, and life for that matter, how to choose depends.
If you look into your crystal ball and it tells you for a fact that tax rates will be higher in the future, you should choose a Roth IRA. Doing so will allow you to pay your taxes now, will let your money grow tax deferred and when you take distributions in the future, as long as you follow a couple of rules, they will be free of any income tax. Sounds great!
What if your crystal ball is wrong though and taxes are actually lower… Well, we should have chosen the traditional IRA. Then we could have avoided those higher tax rates years ago and invested our money pre-tax. It, too, could have grown tax deferred and we could pay taxes when we take distributions at these lower rates. Maybe we need to replace our crystal ball with a magic 8 ball…
Tax rates depend on income but for the example above we will just assume income is around the same while working and in retirement.
As you can see, absent knowing the future, we can’t give a precise answer as to which plan is better. I suggest if you have the ability, use both.
There will be overall contribution limits to keep in mind, and you won’t be able to max out contributions to both, but you can contribute to both. By doing this you are diversifying your tax base and in retirement, and when you take distributions, you can take them as tax efficiently as possible.
There are many, many other factors that play into which type of IRA to invest in and it is best to have a professional review your individual situation.
If you haven’t put together a retirement plan you should contact your CERTIFIED FINANCIAL PLANNER™ to get started immediately.