Roth vs Traditional – Why the Roth IRA Is Better

Both a Roth IRA and a Traditional IRA have tax advantages, but it is my opinion that the Roth is a better way to go. In this article, I’ll explain why.

What is a Roth IRA?

A Roth IRA is an individual retirement account (IRA) that allows qualified withdrawals on a tax-free basis.

This means you pay taxes on that money now, but pay nothing when you take that money out (tax-free).

A Roth means you pay no taxes on the growth – which is sweet. If you have millions of dollars come retirement, all that money is yours – not Uncle Sam’s.

Here are a few things to remember about a Roth IRA:

  • You can’t contribute to a Roth unless you have earned income.
  • You can’t contribute to a Roth if you make too much money (currently that amount is $139,000 for singles, or $206,000 for married couples).
  • There are caps on how much you can contribute in a year (currently it is $6,000, unless you are over 50 – then you can do $7,000).
  • They are easy to open online, through any bank, or investment company.
  • There are no required minimum distributions (RMDs).

Related: Best Vanguard Funds for Roth IRA

What is a Traditional IRA?

A Traditional IRA is an individual retirement account (IRA) that allows qualified withdrawals on a tax-deferred basis.

This means you pay no taxes on that money now, but pay taxes when you take that money out (tax-deferred).

A traditional IRA is similar to a company 401(k) in that they’re both tax-deferred retirement accounts.

Related: Best Funds for Your Company 401(k)

Here are a few things to remember about a Traditional IRA:

  • There are caps on how much you can contribute in a year (currently it is $6,000, unless you are over 50 – then you can do $7,000).
  • They are easy to open online, through any bank, or investment company.

Which is better?

Although both have tax advantages and are great ways to save for retirement, I think the Roth is the better way to go.

To help you see why, let’s imagine someone making $40,000 a year over a 40 year period.

A $40k example

Say, Mike wants to invest for retirement; he wants to invest 15% of his income like Dave Ramsey recommends.

Since Mike makes $40k a year, 15% would be $6,000 a year. That’s equivalent to $500 a month.

Related: How to Become a Millionaire Making $40k a Year

Whether that $500 is invested in a Roth IRA or a Traditional IRA, Mike will have saved the same amount for retirement (assuming he invests either the same way).

That leaves Mike with $5.8M after 40 years of investing (assuming an average rate of return of 12%).

You can check those numbers here using this retirement calculator if you’d like.

If Mike’s nest egg ends up being the same at retirement, does it really matter whether he goes with a Roth IRA or Traditional IRA?

Absolutely.

Let’s see how the numbers actually play out.

On a Traditional IRA

Mike pays no taxes on the amount he contributes towards retirement. So if he contributes $6,000 a year, he only has to pay taxes on $34k.

Basically, he reduced his taxable income by $6,000 a year – easy enough.

If Mike’s tax rate is 15%, that’s $5,100 a year on $34k.

Over the course of 40 years, that’s a total of $204,000 paid in taxes.

At retirement, Mike would have $5.8M using the calculator above. But he would still have to pay taxes on that amount.

Assuming he has the same tax rate of 15% at retirement, Mike would have to pay $870k in taxes.

Here’s the verdict:

$5.8M – $870k = $4.9M for Mike at retirement.

On a Roth IRA

Mike pays taxes on all his income at 15%, which is $6,000 a year on $40k.

Over the course of 40 years, Mike will have paid a total of $240,000 in taxes ($36k more than he would of on the Traditional).

At retirement, Mike will still have $5.8M. But he will not have to pay taxes on any of it.

However, he did have to pay that $36k to get here, so let’s figure that in to be fair.

Here’s the verdict:

$5.8M – $36k = $5.76M for Mike at retirement.

Conclusion

Obviously, the Roth is the clear winner – by almost a million dollars!

Of course not everyone will qualify for a Roth, so a company 401(k) or Traditional IRA is a great alternative. Both options have tax advantages (tax-deferred), just not as good as the Roth (tax-free).

So if you qualify for a Roth, take advantage of it – the savings are huge!