In Defense of the Traditional IRA

Roth IRAs are tax-free.  Traditional IRAs are simply tax-deferred.  Surely tax-free is better, right?  And surely, therefore, a Roth IRA is the best way to invest for retirement, right?

Well, not exactly.  I’d argue that the typical terminology is a bit misleading.  Rather than thinking about “tax-free” as compared to “tax-deferred”, I’d suggest thinking about it this way:

  • Roth IRA = “taxed now”
  • Traditional IRA = “taxed later.”

With a Roth IRA, you are taxed. You’re taxed before you even get to put money into the account.  (Then, when it comes out, it’s tax-free as long as you jump through the appropriate hoops.)  With a traditional IRA, you get to contribute money before being taxed on it.  (Then, when it comes out, it’s taxable.)

So which is better: being taxed now or taxed later? The answer is that it depends on how you expect your tax rate in retirement to compare to your current tax rate.

  • If you expect a higher tax bracket in retirement, a Roth is likely better.
  • If you expect a lower tax bracket in retirement, a traditional IRA is likely better.
  • If you have absolutely no clue, it probably makes sense to tax diversify (that is, put some money in each type of IRA).

Estimating Your Future Tax Rate

Many people argue in favor of the Roth because they assume they’ll be in a higher tax bracket in retirement than they’re in right now.  But what if, rather than purely guessing, we actually took a shot at calculating how much money it would take to put you into a given tax bracket in retirement?

Fortunately, fellow blogger Joe Taxpayer has done exactly that.

The answer: If your IRA is your only source of income in retirement, you need a lot of money before you even hit the 25% tax bracket.  Specifically, based on 2010 tax brackets (and a 4% withdrawal rate), you’d need:

  • $467,500 in tax-deferred accounts before anything would be taxable,
  • $886,250 in tax-deferred accounts before moving beyond the 10% tax bracket, and
  • $2,167,500 in tax-deferred accounts before moving beyond the 15% tax bracket.

In addition, because tax brackets are usually adjusted upward in an attempt to keep up with inflation, these numbers will likely be significantly higher if you’re retiring in the distant future.

Dealing with Uncertainty

On the other hand, many people will (correctly) point out that tax rates do change over time, and it’s possible that what is now the 15% tax bracket could quite possibly be, say, a 20% tax bracket a few years down the road.

Most people suggest that such legislative uncertainty is a reason to go for a Roth — the idea being that, since it’s likely tax rates will be higher in the future, it’s best to be able to count on tax-free withdrawals.

However, a similar argument can be made against the Roth. While the tax code is currently set up so that withdrawals are tax-free, there’s no reason that this couldn’t change.  All it would take is the passing of a new law — exactly the same thing that’s required to change tax rates.

And lest you think that this sort of thing could never happen, let me point out that it has happened.  When Social Security was created, it was entirely tax-free.  Now, depending on your income, up to 85% of social security benefits can be taxable.

When a Roth Makes Sense

In short, unless you’re:

  1. In a very low tax bracket right now (say, 0% or 10%), or
  2. Planning to have some source of retirement income other than investments,

…you may want to consider sticking with a traditional IRA — or a tax-deferred plan at work, like a 401(k) — for the bulk of your retirement savings.

About the author: Mike Piper writes at Oblivious Investor where he provides plain-English explanations of topics like Roth IRA withdrawal rules and 2011 tax bracket changes.

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Published or updated May 22, 2013.


  1. That’s the one thing that worries me about Roths…changing legislation. Right now all earnings can be made tax free if you follow the rules. But if the government decides to change that down the road and start taxing those earnings, it will have a HUGE impact on your account balance.

    • Yes, precisely!

      Changes in legislation can have a large impact regardless of what type of account you use. Yet, for whatever reason, most discussion of potential legislative changes tends to focus exclusively on the impact on traditional IRAs.

      • And when you look at the current deficit and the fact that social security is dwindling you have to wonder where government revenue will come from if things aren’t reigned in. Truth is we don’t know what future tax laws hold for us.

        • Debbie M says:

          I don’t think politically they can make the change for money already in Roth IRAs. They could certainly disallow future contributions.

          When looking for more taxes, they can add a national sales tax (getting retirees to pay after all) and raise the other taxes.

          I think they should put off the retirement age for Social Security. They’ve only barely done this, moving it from 65 – 67, with plenty of grandfathering.

  2. Matthew Pryor says:

    It mostly comes down to whether you expect to be in a lower tax bracket when you retire than you are now? If so, choose a traditional IRA. You get a tax benefit now while your rates are higher, AND pay tax later when your rate is (hopefully) lower. This is a double benefit many people overlook.

  3. Very interesting article. I realized the difference between Roth and Traditional before, but I hadn’t thought about the future consequences. Thanks!

  4. I try not to worry about things I have no control over in the future, so we diversify.

    I put in the minimum to my 401(k) to get the max company match (6%) and we fully fund a Roth IRA. We’re hoping to fully fund two this year. I figure if they change the rules, they may grandfather in previously made contributions…even if they don’t, at least we have the 401(k) and a pension as backup. If Roth IRA’s actually stay the way they are, our plan is to balance our withdraws in the way that can keep us in the lowest tax bracket as possible in retirement.

    • “I put in the minimum to my 401(k) to get the max company match (6%) and we fully fund a Roth IRA.”

      Sounds like a good plan to me. 🙂 In fact, that’s exactly what I did before going self-employed.

  5. It is also worth considering that the capital gains and the dividends in the traditional IRA are treated the same. It would be interesting to compare a traditional IRA with a long term tax efficient taxable portfolio over a period of many years to see which one comes out better. Atleast, with a taxable account there is much more flexibility

  6. I honestly think doing a ROTH is a bozo move for most people.

    “Be A Sloth, And Don’t Roth!”

  7. I would only consider a Roth AFTER I had made the max contribution to my 401k…

  8. Traditional IRAs are near useless. They’re really only nice if your make quite a lot and want that extra $5,000 tax deferred after your 40, although you might only get partial our noon of the tax benefits. Most people don’t realize if you have a 401I you may not be eligible for taxbenefits from a traditional. Most people seem to think that everything from your Roth is taxable, most people don’t realize that 5,000 over 40 years at 6.8% wool result on $750,000 untaxed and only $200,000 taxed. A Roth I’d a beautiful thing, you need to be in a very high bracket to not receive a larger benefit from the Roth.

  9. Sorry for the phone typos, 40 is 401k, noon ours none, 401k is 401k wool is will.

  10. sterling harris says:

    so, I am already retired and living off my retirement. since my tax rate is already fixed (unless the gov’t changes it)…is there really an advantage of traditional ira vs roth ira?

  11. Matt Peplowski says:

    And what about the power of compounding? You lose a lot of that power with the Roth, do you not, because you’re money is compounding off of money that was already taxed. Paying the taxes later is better because you’ll have a lot more money! Does that make sense or am I way off?

    • Compounding is as effective in either situation, assuming the marginal tax rate now is the same as the marginal tax rate at the time of distributions.

      Investment returns and taxes are each multiplication functions (e.g., multiplying by 1.08 in a year to reflect an 8% return or multiplying by 0.75 to reflect a 25% tax).

      And the commutative property of multiplication tells us that the order of multiplication doesn’t matter. That is, we get the same answer whether we multiply by 0.75 at the beginning or at the end.

  12. Dan Snyder says:

    Not a bad article except it left out a few key issues.

    First, while you do have to pay tax on the Roth contributions – the amount you can contribute is the same. So effectively a Roth allows you to contribute more money, creating more income to be earned tax free. So the author is comparing apples and oranges. Secondly, the author then forgets to mention that it is not just the contributions which are taxed vs non taxed but the income as well.

    So the reality is the Roth, especially for a younger person, has far more advantages

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