One of the most common questions we get surrounding IRA contributions is whether they should be Roth or Traditional contributions. While everybody has different situations, it is crucial to consider your current tax liability, retirement tax liability, and balance both with your lifetime tax liability.
For the sake of this example, we are only going to consider initial contributions to IRAs. If you are interested in backdoor Roth contributions, Solo 401(k) contributions, or the Mega Backdoor Roth strategy, our team has written a full white paper:
Assumptions:
7% Annual Return
24% Tax Bracket
Note: For the Roth IRA, the total value of the account is reflected. For the Traditional IRA, the balance reported is the value of the account plus the tax savings from making pre-tax contributions.
Example 1:
| Total Contributions | $165,000 |
| Roth Account Balance | $550,902 |
| Traditional Account Balance + Savings | $531,208 |
Keep in mind that the benefits of a Roth are even higher, as the entire balance of the account can be withdrawn from the account tax-free in retirement, while the traditional balance withdrawals will owe taxes.
Example 2:
| Total Contributions | $110,000 |
| Roth Account Balance | $241,258 |
| Traditional Account Balance + Savings | $235,736 |
Example 3:
| Total Contributions | $55,000 |
| Roth Account Balance | $81,310 |
| Traditional Account Balance + Savings | $81,171 |
While all folks who make Roth contributions enjoy tax-free withdrawals in retirement, the effects compound the longer you contribute to a Roth account. Simply stated, the longer the Roth money is allowed to grow, the more significant the benefits.
The nature of the types of investments allowed within a self-directed account can also heavily tip the scales in favor of a Roth account. If you make a startup investment that pays off, withdrawals in retirement could be heavily taxed, while a significant investment win in a Roth account will be tax-free. For a startup or real estate investment, Roth accounts can save you a lot of money in retirement income taxes.
It is important to keep in mind that not everyone can make Roth IRA contributions, as there are income limits, which, if you make too much, disqualify you from making yearly contributions.
However, there are more ways to fund Roth accounts than direct contributions. Our team has written the Rocket Dollar Guide to Roth Retirement Accounts, which is available for free as a PDF download.
Another essential factor to keep in mind is your expected tax bracket in retirement. Depending on your situation, the tax savings of making contributions might negate the future benefits of tax-free withdrawals. The examples above are simple, and everyone has a different situation, so it is necessary to consider all options.
Thomas Young: May 19 2023
In today's fast-paced world, it's easy for individuals to lose track of their old 401(k) accounts from previous employers. For many folks, job...
Thomas Young: May 05 2023
Investing in alternative assets can be a great way to diversify your portfolio and potentially achieve higher returns. One way to invest in these...
Thomas Young: April 14 2023
When most people think of investing, they typically think of stocks, bonds, and mutual funds. However, there are also alternative investments that...
