The fact is most taxpayers like the idea of having tax free income and paying less income taxes. It is true, qualified Roth retirement accounts can provide tax-free income to you during retirement, but what cost might you pay for this gratitude?

For example, you contribute $5,000 per year to a qualified Roth retirement account for 30 years.   At 7% annual return the account will allow you then to withdraw $46,000 per year over 20 years. Combined with $20,000 annual social security income, your income would be $66,000 per year.  With today’s tax rates, and assuming you were married, you would pay no income tax on that amount.

Now, let’s take the same facts, but instead you contribute $6,580 to a qualified deferred account like a traditional 401k or traditional IRA.   If you were in the 24% tax bracket you would have the same net outlay of $5,000 due to the immediate tax savings.  Assuming the same rate of return, the account, combined with social security would provide $79,000 in taxable income over 20 years.  And while this extra income will cause your social security to be taxable, the total tax would only be $5,500 for an after tax income of $73,500.

Wow, by having used the deferred account in the second example, your after-tax income is $7,500 more each year for 20 years!  Why did this work out that way?

It is simple, when contributing after-tax dollars to a Roth account you are locking in today’s marginal tax rate on those contributions, and paying the tax—at 24% in the example.  However, a regular IRA works just the opposite:   When contributing to a deferred retirement account you are getting a deduction at your top marginal tax rate, then later paying income tax using marginal rates that were lower, in the example.

So which is the right answer for me?  Roth or Regular?

Well that depends, and this article oversimplifies the mathematics and other considerations, such as that Required Minimum Distributions are not required for Roth IRAs.  Also, there is a bit of gaming involved as we don’t know the tax rates in retirement, nor will we know your income.  But it generally comes down to this: If you are in a low tax bracket today (12% or less), the ROTH is a no-brainer.  However, if you are in a high tax bracket today—and you expect to be in a lower bracket in retirement, it is generally better to take the tax benefit today.  After all, we all know the saying about a bird in the hand vs. the one in the bush.

Not all taxpayers or situations are created equal. Please consult your tax advisor and financial advisor before making any changes to your current retirement plan.