NATALI MORRIS

Natali Morris Blog

September 1, 2015

Roth vs Traditional IRAs and 401(k)s. Which Should You Choose?

Roth vs Traditional

Are you planning on retiring poor? That is an important question to ask yourself when choosing between a Roth and a Traditional investment account. Let’s discuss.

When you open an IRA or a 401(k), you are given a choice: Roth or Traditional.

A Roth means that you put money into that account after it has been taxed by the government on your paycheck or on your tax returns. This means the government can suck it when it is time to withdraw that account in your retirement.

A Traditional account means that you put money into the account before it has been taxed by the government.  This means that you can suck it when it is time to withdraw that account because the government will be helping itself to your retirement.

Make no mistake: the government WILL take its cut of this money. It’s not if. It’s when. Which puts the question to you: When is this tax better for you and your family?? In most cases, the ideal answer is right now.

When I was first given the choice between a Roth and a Traditional 401(k), I remember having this conversation with myself:

Self, do I plan to be in a higher tax bracket when I retire? 

You bet your booty I do! I plan to have to order one of those extra booklets for my passport because it is so stamped up with exotic stamps! Damn yes. I plan for wealth. 

This is why I am a big fan of Roth over Traditional retirement accounts!

If you retire poorer than you are now, you will be in a lower tax bracket. With a Traditional 401(k) or IRA, the government will take a smaller piece out of your withdrawal than it would if you were wealthier, but it will still be a piece of the whole pie. This will hurt considering it is the last pie you are going to bake.

However, if you retire with wealth, you will not want the government taxing your lump of cash when it matures! You will be in a higher tax bracket, no matter who is President, and that will mean a bigger chunk for the government.

But imagine if you have a Roth! Your account reaches maturity, it is humongous, and you withdraw it in its entirety with a big middle finger to the government!

Of course there are some disadvantages to a Roth account. You take home less money in your paycheck during your earning years and that can hurt. You also miss a chance to write off this investment on your annual tax return if you have an IRA. But this is a classic example of delayed gratification resulting in a bigger payoff. Let’s run the numbers.

Say you invest just $1,000 in a retirement account in a year that you are in a 25% tax bracket. With a ROTH, you will have paid 25% tax on that money. With a Traditional, you will have paid none.

Now let’s say that investment does moderately well. With compound interest around 5% for 20 years, that $1,000 will be worth over $2,600. Let’s say you are wealthy in retirement (because you’re a great CHO!) and are in a 33% tax bracket. So:

Do you want to pay 25% on $1,000 when you are still working with a Roth? That costs you $250.

OR

Do you want to pay 33% on $2,600 when you are about to retire with a Traditional? That costs you $858.

These are small numbers for example’s sake! Consider that most withdrawals at age 65 range from $743,000 to $3,500,000 and imagine taxing that stash! No thanks! I’ll take the small regular tax hits while I am still earning any old day!

I will grant you, this takes some juevos. You have to believe that you are going to do well into retirement. You have to be willing to live on less cash today in order to have more down the road.

How can I know for sure that I’ll be wealthy in my Golden Girl years? Of course I can’t but I believe in my family and my ability to make conscious investments! Stick with me and you will too!

Next up on the CHO management crash course:

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9 responses to “Roth vs Traditional IRAs and 401(k)s. Which Should You Choose?”

  1. Bob M says:

    You can rollover your 401k into an IRA and withdraw over time which gives you some ability to control your income and thereby prevent the huge tax and bracket of a lump sum. Also if you are already in the top bracket, the deduction the 401k pretax contribution provides may be advantageous.

  2. BubbaChris says:

    Your example above is not Apples-to-Apples. For the Roth IRA you’re paying $1,250 per year out of today’s budget (The $1,000 going into the Roth, plus the $250 in taxes). And the gap between the two is even larger than that if you consider the tax advantages of the Traditional IRA in the current year. So when you consider a truly equal impact on today’s dollars available to live on, and add in the magic of compound interest, the Traditional IRA may be an excellent way to start early in your career. I’d rather be taxed on the appreciation later than not have enough to put away today.

  3. jj says:

    Since you can’t guarantee that you will be wealthy in retirement, this is terrible advice. You have not considered risk. You may get sick, you may lose your job, life happens. If you use a Roth, you have more money when you are already wealthy, and less money if you are poor. With a traditional 401K, you have less money if you are wealthy and more money if you are poor. But if you are wealthy you don’t need the extra money from the Roth. If you are poor, then every dollar counts and the extra money from the traditional 401K is important. The risk-reward profile is clear. Pick the option that gives more money if you need it, and less money if you don’t. That is the 401k.

    • Natali Morris says:

      I see your point but wouldn’t you rather put more money in the fund while you’re actually working and pay taxes on it while you are still working? Paying taxes on something while you are in hardship adds insult to injury!

  4. pb says:

    Isn’t your tax rate going to be based on your income, not your wealth? And when you retire you’ll have zero income and thus the lowest tax bracket?

    • Nathan says:

      Pensions, Social Security, and Tax Deferred investment withdrawls will count as income. Plus income tax overall will probably be higher even if you are in the same tax bracket at retirment.

  5. Julia says:

    Funds can be either transferred to another institution or they can be sent to the owner of the traditional IRA who has 60 days to put the money in another institution in a rollover contribution to another traditional IRA

  6. Darren says:

    I understand the reasoning behind choosing Roth over Traditional, but what about performing a Roth Conversion Ladder? Just wondering

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